Price Elasticity of Demand (PED)

Definition: Price elasticity of demand (PED) measures the responsiveness of demand to a change in price.

In essence, this means we are interested in knowing how consumers react to a change in price. For example, if the price of petrol rises 10%, we would expect only a small decline in demand (price inelastic) because most drivers have little alternative but to keep buying petrol.
However, if the price of a Big Mac increased 10%, we might expect a bigger fall in demand (price elastic), because consumers have many different options for fast food, they could easily switch to similar, but cheaper foods.

Example of PED

If price of Samsung phone increases by 10% and demand for Samsung phone fell by 20%
Then PED = -20/10 = -2.0

If the price of petrol increased from £1.30 to £1.40 and demand fell from 10,000 units to 9,900
% change in Q.D = (-100/10,000) *100 = – 1%
% change in price 10/130 ) * 100= 7.7%
Therefore PED = – 1/7.7 = -0.13

If you need help calculating a percentage, see: How to calculate a percentage

If price increase from £50 to £55 and PED was 0.5
How much did quantity demanded fall?
0.5 = % change in QD
Therefore % QD = -5
Test Yourself – PED Calculations

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Price Elastic Demand

Definition: Demand is price elastic if a change in price leads to a bigger % change in demand; therefore the PED will, therefore, be greater than 1.

Goods which are elastic, tend to have some or all of the following characteristics.

They are luxury goods, e.g. sports cars
They are expensive and a big % of income e.g. sports cars and holidays
Goods with many substitutes and a very competitive market. E.g. if Sainsbury’s put up the price of its bread there are many alternatives, so people would be price sensitive.
Bought frequently

Examples of goods with elastic demand

Designer on online platforms, such as Fiverr – they face huge competition from other designers around the world
Volvic mineral water – there are many other types of mineral water which are very similar.
Apple TV – If Apple TV increases its subscription charges, consumers may not want to pay because there are so many other alternatives netflix, youtube e.t.c.

Price Inelastic Demand

These are goods where a change in price leads to a smaller % change in demand; therefore PED <1 e.g. – 0.5

Inelastic demand PED <1 – Perfectly inelastic PED =0

Features of Goods with Inelastic Demand

They have few or no close substitutes, e.g. petrol, cigarettes.
They are necessities, e.g. if you have a car, you need to keep buying petrol, even if price of petrol increases
They are addictive, e.g. cigarettes.
They cost a small % of income or are bought infrequently.

In the short term, demand is usually more inelastic because it takes time to find alternatives
If the price of chocolate increased demand would be inelastic because there are no alternatives, however, if the price of Mars increased there are close substitutes in the form of other chocolate, therefore, demand will be more elastic.

Examples of goods with inelastic demand

Petrol – car drivers can’t avoid it
Cigarettes – people are addicted
Electricity – few alternatives
iPhone – many consumers are attached to Apple brand of phones
Ticket for Liverpool F.C. – For Liverpool fan, no real alternative

Using Knowledge of Elasticity

1. If demand is inelastic then increasing the price can lead to an increase in revenue. This is why OPEC try to increase the price of oil.

Graph showing increase in Revenue following increase in price

2. If demand is elastic, firms would be unlikely to increase revenue as this could lead to a fall in revenue. Instead, they could try advertising to increase brand loyalty and make demand more inelastic

3. Price Discrimination. Some people pay higher prices for tickets for trains because their demand is more inelastic.

Adults (with more inelastic demand) face higher prices. Students with more elastic demand get lower price.

4. Tax incidence. If demand is price inelastic, then a higher tax will lead to higher prices for consumers (e.g. tobacco tax). The tax incidence will mainly be borne by consumers. If demand is price elastic, firms will face a bigger burden, and consumers will have a lower tax burden.

Price Elasticity Over Time

In the 1970s, when oil prices tripled, demand was very inelastic because cars were not fuel efficient, and there was little alternative. However, the shock of oil prices tripling encouraged firms and consumers to seek out alternatives. Firstly cars were made more fuel-efficient, reducing the amount of petrol. In recent years, the growth of electric cars is likely to be make demand for petrol (gasoline) less inelastic. In other words, if the price of oil and petrol rises, then it creates an incentive for consumers to switch to an electric car.

In the short-term, higher prices don’t reduce demand, because you need to fill up. But, if the high prices are sustained, then it will definitely influence the choice of the next car.

The role of the internet

Demand for bank services used to be quite inelastic, consumers tended to stick with same bank their entire life. But, with rise of internet banking, the market has become more competitive and it is easier to switch. So arguably demand for banking services has become more price elastic than in the past.

Test Yourself at PED