The Allocation of Resources – Price Elasticity of Demand (PED)
Definition of PED
Price Elasticity of Demand (PED) measures how much the quantity demanded of a good changes when its price changes.
It tells us whether consumers are price sensitive or not.
Think of it like this: If the price of your favourite snack rises, will you buy much less, or will you still buy almost the same amount? PED captures that reaction.
| Formula | Interpretation |
|---|
\${\displaystyle PED = \frac{\% \Delta Q_d}{\% \Delta P}}\$ | - Positive value (always positive because we use absolute values)
- Higher value → more elastic (big change in quantity for a small price change)
- Lower value → inelastic (small change in quantity for a big price change)
|
Quick Example with Emojis
📦 Product: Ice Cream 🍦
📈 Price increases by 20% (from \$2 to \$2.40)
📉 Quantity demanded falls by 10% (from 100 units to 90 units)
\${\displaystyle PED = \frac{10\%}{20\%} = 0.5}\$
Since 0.5 < 1, demand is inelastic – people still buy a lot of ice cream even when it’s more expensive.
Analogy: The “Elastic Band”
Imagine an elastic band stretched between your fingers.
- 🔧 Elastic demand: The band snaps back quickly – quantity changes a lot when price changes.
- 🧱 Inelastic demand: The band is stiff – quantity hardly changes even if price changes.
This visual helps remember that the elasticity value tells us how “stretchy” demand is.
Exam Tips
- Always use the absolute value of PED in your answer.
- Remember: PED > 1 → elastic, PED < 1 → inelastic, PED = 1 → unit‑elastic.
- Show the calculation step‑by‑step: write the percentage changes, then divide.
- Use a short example (like the ice cream) to illustrate your point.
- Highlight the implication for firms: if demand is elastic, a price cut can increase revenue.