📚 The Allocation of Resources – Price Elasticity of Demand (PED)
What is PED?
Price Elasticity of Demand measures how much the quantity demanded of a good changes when its price changes.
Formula (inline): \$Ed = \dfrac{\% \Delta Qd}{\% \Delta P}\$
Formula (block):
\$Ed = \dfrac{\% \Delta Qd}{\% \Delta P}\$
Where \$\% \Delta Q_d\$ = percentage change in quantity demanded, and \$\% \Delta P\$ = percentage change in price.
Example: Calculating PED
Suppose the price of a video game rises from \$10 to \$12 (a 20% increase). The quantity demanded falls from 100 to 80 units (a 20% decrease).
\$E_d = \dfrac{-20\%}{+20\%} = -1.0\$
Because the absolute value is 1, the demand is unitary elastic.
Elasticity Types
| Category | PED (|E_d|) | Interpretation |
|---|
| Elastic | > 1 | Quantity changes more than price. |
| Unitary Elastic | = 1 | Quantity changes proportionally to price. |
| Inelastic | < 1 | Quantity changes less than price. |
| Perfectly Elastic | ∞ | Consumers switch goods instantly at any price change. |
| Perfectly Inelastic | 0 | Quantity demanded never changes, no matter the price. |
Implications for Consumers 👥
- Elastic Demand: A small price rise leads to a big drop in purchases. Consumers will look for cheaper alternatives. Example: luxury cars.
- Inelastic Demand: Price changes have little effect on buying. Example: life‑saving medication.
- Unitary: Total revenue stays roughly the same when price changes.
Implications for Workers 💼
- When demand for a product is elastic, firms may cut production if prices fall, leading to fewer jobs.
- With inelastic demand, firms can maintain or even increase output, providing more stable employment.
- Workers in sectors with highly elastic demand (e.g., fashion) face higher job insecurity.
Implications for Producers/Firms 🏭
- Elastic demand → price cuts can boost sales volume but may reduce profit margins.
- Inelastic demand → firms can raise prices to increase revenue without losing many customers.
- Understanding PED helps firms set optimal pricing strategies and forecast sales.
Implications for Government 🏛️
- Taxation: Imposing a tax on an inelastic good (e.g., cigarettes) leads to less reduction in consumption, generating higher revenue.
- Subsidies: Subsidizing an elastic good (e.g., public transport) can significantly increase usage.
- Price controls: Setting price ceilings on elastic goods may cause shortages; price floors on inelastic goods can lead to surpluses.
Exam Tips 📚✏️
- Remember the formula: PED = (ΔQ/Q) ÷ (ΔP/P). Use percentages to avoid negative signs.
- When asked to interpret a PED value, state whether demand is elastic, inelastic, or unitary.
- Use real‑world examples (e.g., smartphones, petrol) to illustrate implications for different stakeholders.
- Show your work clearly; teachers look for correct calculation and correct sign.
- Practice converting between absolute value and sign: a negative PED indicates the inverse relationship.