Cambridge IGCSE Economics 0455 – Price Elasticity of Demand
Price Elasticity of Demand (PED)
Price elasticity of demand measures how much the quantity demanded of a good changes in response to a change in its price. It is a key concept for understanding how resources are allocated in the market.
Suggested diagram: Demand curve with two points showing elastic and inelastic segments.
Formula and Calculation
The basic formula is:
\$PED = \dfrac{\% \Delta Q_d}{\% \Delta P}\$
Where:
\$\% \Delta Q_d\$ = percentage change in quantity demanded
\$\% \Delta P\$ = percentage change in price
For classification, the absolute value of PED is used.
Classification of Elasticity
Elasticity
Absolute \cdot alue
Interpretation
Elastic
\$>1\$
Quantity demanded changes more than price.
Unitary Elastic
\$=1\$
Quantity demanded changes proportionally to price.
Inelastic
\$<1\$
Quantity demanded changes less than price.
Implications for Decision-Making
Consumers
When demand is elastic, consumers are highly responsive to price changes and will reduce consumption significantly if prices rise.
When demand is inelastic, consumers are less responsive; price changes have a smaller effect on quantity demanded.
Example: Luxury goods (elastic) vs. basic food items (inelastic).
Workers
Elastic demand for labour occurs when the product’s demand is elastic; firms may cut employment if wages increase.
Inelastic demand for labour means employment is less sensitive to wage changes, offering greater job security.
Implications for wage negotiations and the impact of minimum wage policies.
Producers/Firms
Pricing strategy: firms set prices where marginal revenue equals marginal cost, taking elasticity into account.
Revenue maximisation: increase price if demand is inelastic; lower price if demand is elastic.
Production planning: adjust output levels based on expected demand elasticity.
Capacity expansion decisions: evaluate potential revenue changes from elasticity before investing.
Government
Taxation: taxes on inelastic goods raise revenue with minimal reduction in quantity sold.
Subsidies: more effective on elastic goods, encouraging greater consumption.
Price controls: need to consider elasticity to avoid excess supply or shortages.
Welfare analysis: assess how price changes affect consumer and producer surplus.
Case Studies
Tax on cigarettes: demand is relatively inelastic, so the tax generates significant revenue but has limited effect on consumption.
Subsidy for electric cars: demand is elastic, so subsidies effectively increase adoption rates.
Minimum wage increase: the elasticity of labour demand determines whether employment levels will fall.
Key Takeaways
Understanding PED helps predict consumer behaviour and market responses.
Elasticity informs pricing, production, and policy decisions across all stakeholders.
Stakeholders must assess elasticity to optimise outcomes and allocate resources efficiently.