A measure of the **responsiveness** of quantity demanded when there is a price change. ## The Formula for PED [block_2] Price elasticity of demand is defined as the **percentage change in quantity** **demanded **divided by the **percentage change in price**. $$ \mathrm{PED} = \frac{\%\Delta Q_d}{\%\Delta P}$$ Where: * $\%\Delta Q_d$ = Percentage change in quantity demanded * $\%\Delta P$ = Percentage change in price [{"_key":"block_11","_type":"block","asset":null,"children":[{"_key":"H4lKdx2AthRpksOOBtJvaw","_type":"span","markDefs":[],"marks":[],"text":"To calculate percentage changes, use this formula: "}],"markDefs":[],"style":"normal"},{"_key":"8c379eddf6aa","_type":"block","asset":null,"children":[{"_key":"7f89ad6e6d0c","_type":"span","markDefs":[],"marks":[],"text":"$$\\%\\Delta X = \\frac{\\text{New Value} - \\text{Old Value}}{\\text{Old Value}} \\times 100$$"}],"markDefs":[],"style":"normal"},{"_key":"b0598c53a9c0","_type":"block","asset":null,"children":[{"_key":"dffd1423e90a","_type":"span","markDefs":[],"marks":[],"text":"This gives you the percentage change from "},{"_key":"3a2063d13e85","_type":"span","markDefs":[],"marks":["strong"],"text":"Old Value"},{"_key":"ddc73adf4cf5","_type":"span","markDefs":[],"marks":[],"text":" to "},{"_key":"3761ac7f8f3d","_type":"span","markDefs":[],"marks":["strong"],"text":"New Value"}],"markDefs":[],"style":"normal"}] [{"_key":"a2363088401f","_type":"block","asset":null,"children":[{"_key":"b2f804ea5583","_type":"span","marks":[],"text":"The formula above works for "},{"_key":"38baa03aca04","_type":"span","marks":["strong"],"text":"linear (straight-line demand curves)"},{"_key":"9bc74c5d1efd","_type":"span","marks":[],"text":" and is a good "},{"_key":"c6770a249419","_type":"span","marks":["strong"],"text":"approximation"},{"_key":"97174a2525dc","_type":"span","marks":[],"text":" for others."}],"markDefs":[],"style":"normal"},{"_key":"d5798ff0c8f5","_type":"block","asset":null,"children":[{"_key":"1dab89117f0f","_type":"span","marks":[],"text":"The "},{"_key":"7af572f61372","_type":"span","marks":["strong"],"text":"exact percentage change and elasticity"},{"_key":"ab9683df0f91","_type":"span","marks":[],"text":" for non-linear curves concerns the "},{"_key":"8e14495d13b8","_type":"span","marks":["strong"],"text":"derivative"},{"_key":"f3fa16ef451a","_type":"span","marks":[],"text":" which is "},{"_key":"fe9caca1c9f7","_type":"span","marks":["em"],"text":"not part of this syllabus."}],"markDefs":[],"style":"normal"}] Therefore, using the above formulas, **PED** can be written as: $$ \mathrm{PED} = \frac{\frac{Q_{new}-Q_{old}}{Q_{old}}\times 100}{\frac{P_{new}-P_{old}}{P_{old}}\times 100} = \frac{\frac{Q_{new}-Q_{old}}{Q_{old}}}{\frac{P_{new}-P_{old}}{P_{old}}}=\frac{\frac{\Delta Q}{Q_{old}}}{\frac{\Delta P}{P_{old}}} $$ [{"_key":"81d215de86c6","_type":"block","asset":null,"children":[{"_key":"f17c6bb9bd56","_type":"span","marks":[],"text":"If we know that "}],"markDefs":[],"style":"normal"},{"_key":"f19ae0beed7e","_type":"block","asset":null,"children":[{"_key":"39020d0c26a3","_type":"span","marks":[],"text":"At a price $P_1 = \\$ 50$ people buy $Q_1=30$ bars of chocolate."}],"level":1,"listItem":"number","markDefs":[],"style":"normal"},{"_key":"62e2f920b0cf","_type":"block","asset":null,"children":[{"_key":"d1fa7351ba11","_type":"span","marks":[],"text":"At a price $P_2 = \\$ 100$ people buy $Q_2 = 15$ bars of chocolate. "}],"level":1,"listItem":"number","markDefs":[],"style":"normal"},{"_key":"8daf67a19b90","_type":"block","asset":null,"children":[{"_key":"bb45f75167e2","_type":"span","marks":[],"text":"Then we can calculate the $PED$ by using the formula above."}],"markDefs":[],"style":"normal"},{"_key":"a5a36f66494c","_type":"block","asset":null,"children":[{"_key":"6a218e57a8e7","_type":"span","marks":[],"text":"$\\%\\Delta P = \\frac{100-50}{50}\\times 100 = \\% 100$, since the price doubled."}],"level":1,"listItem":"number","markDefs":[],"style":"normal"},{"_key":"248e6f007720","_type":"block","asset":null,"children":[{"_key":"5a79b4cc8464","_type":"span","marks":[],"text":"$\\%\\Delta Q_d = \\frac{15 - 30}{30}\\times 100 = - \\% 50$."}],"level":1,"listItem":"number","markDefs":[],"style":"normal"},{"_key":"8852be776f67","_type":"block","asset":null,"children":[{"_key":"d27759060c1a","_type":"span","marks":[],"text":"Hence the "},{"_key":"b8faa3cde941","_type":"span","marks":["strong"],"text":"price elasticity of demand "},{"_key":"5bd7cb451fdd","_type":"span","marks":[],"text":"would be:"}],"markDefs":[],"style":"normal"},{"_key":"73b386fa4fa8","_type":"block","asset":null,"children":[{"_key":"1c13099c67e5","_type":"span","marks":[],"text":"$$ PED = \\frac{-\\% 50}{\\% 100} = -\\frac{1}{2}$$"}],"markDefs":[],"style":"normal"}] [{"_key":"f35ecdb8d58a","_type":"block","asset":null,"children":[{"_key":"990ba085d711","_type":"span","marks":[],"text":"For the example above, we would get a "},{"_key":"bfdf9eec29a0","_type":"span","marks":["strong"],"text":"different"},{"_key":"7c659573a917","_type":"span","marks":[],"text":" $PED$ if we used $P_2,Q_2$ as our initial values and $P_1,Q_1$ as the new one "},{"_key":"69a2a21fe4b6","_type":"span","marks":["em"],"text":"(you can try this yourself)"}],"markDefs":[],"style":"normal"},{"_key":"e4535164aa21","_type":"block","asset":null,"children":[{"_key":"153d170a8c90","_type":"span","marks":[],"text":"Hence, the above $PED$ would be written as the "},{"_key":"49dd180a5c6b","_type":"span","marks":["strong"],"text":"price elasticity of demand at "},{"_key":"48e449e52172","_type":"span","marks":[],"text":"$\\mathbf{P_1}$ because at $P_2$ the value is different."}],"markDefs":[],"style":"normal"}] As we can see, the **price elasticity of demand** is negative. 1. That is because of the law of demand, the percentage change of quantity demanded will be in the **inverse** of the percentage change of price. 2. Therefore **PED **is mathematically **always negative**. However, for **easier interpretation**, economists use the **absolute value** of PED such that the PED calculated will just be noted as $\frac{1}{2}$ instead of $-\frac{1}{2}$. ## Degrees of PED: Theoretical Range of Values [block_12] PED values help classify demand into different categories _(we take the absolute values)_: #### Price Inelastic [497a4febe490] 1. When $0 < PED < 1$, the demand is called **price inelastic**. 2. Here, the percentage change in quantity demanded is **less than** the percentage change in price. 3. Therefore $PED$ is **smaller** than 1 and the quantity demanded is **highly unresponsive**. #### Price Elastic [77136ad28450] 1. When $1 < PED < \infty$, the demand is called **price elastic**. 2. Here, the percentage change in quantity demanded is **more than** the percentage change in price. 3. Therefore $PED$ is **greater** than 1 and the quantity demanded is **greatly responsive**. ### Special values of PED [d6fcc8330da1] _Figure 1_ below showcases the **three special values** the **PED** of a **demand curve **can take. ![](https://cdn.sanity.io/images/w7j7fz60/production/7a6abc3b301bb16c93c7ba43a815426e30d3d363-2400x812.png) #### Unit Elastic [96115062cc27] 1. When $PED = 1$, the demand is called **unit price elastic**. 2. Here, the percentage change in quantity demanded is **equal to** the percentage change in price. 3. Therefore $PED$ is **equal** to 1 and the quantity demanded is **exactly **as responsive to the price. [{"_key":"1a98445e9f4f","_type":"block","asset":null,"children":[{"_key":"0b4aaab41e3f","_type":"span","marks":[],"text":"Why is the unit elastic demand curve in "},{"_key":"2c2ff992d526","_type":"span","marks":["em"],"text":"Figure 1"},{"_key":"bb9a18f1a6ae","_type":"span","marks":[],"text":" unit elastic if it appears steep and the x and y axis have the same scale?"}],"markDefs":[],"style":"h4"},{"_key":"d0d12fa22db3","_type":"block","asset":null,"children":[{"_key":"42e791a3765d","_type":"span","marks":[],"text":"Many students make the mistake of thinking the demand on the left diagram in F"},{"_key":"809e1b559f81","_type":"span","marks":["em"],"text":"igure 1"},{"_key":"1f8bcf9e57f7","_type":"span","marks":[],"text":" is "},{"_key":"97e23051acad","_type":"span","marks":["strong"],"text":"inelastic"},{"_key":"badf40ad52dd","_type":"span","marks":[],"text":", since the axis have "},{"_key":"c98f01532c6f","_type":"span","marks":["strong"],"text":"the same scale"},{"_key":"307876592432","_type":"span","marks":[],"text":" and it is clearly "},{"_key":"fd9d4adf73c5","_type":"span","marks":["strong"],"text":"steep"},{"_key":"eeb87c20a51c","_type":"span","marks":[],"text":"."}],"markDefs":[],"style":"normal"},{"_key":"25b2ab56388e","_type":"block","asset":null,"children":[{"_key":"4ff6b1ee389f","_type":"span","marks":[],"text":"However, this is not the case. Remember:"}],"markDefs":[],"style":"normal"},{"_key":"fb954ac6544f","_type":"block","asset":null,"children":[{"_key":"37fd232aba74","_type":"span","marks":["strong","em"],"text":"PED"},{"_key":"798a3cbea4a1","_type":"span","marks":["em"],"text":" is defined as the "},{"_key":"b350101f0a39","_type":"span","marks":["strong","em"],"text":"percentage change in quantity"},{"_key":"078560e6bcd6","_type":"span","marks":["em"],"text":" "},{"_key":"5c497c2163ed","_type":"span","marks":["strong","em"],"text":"demanded"},{"_key":"51e9c932f4a0","_type":"span","marks":["em"],"text":" divided by the "},{"_key":"95237d0d4242","_type":"span","marks":["strong","em"],"text":"percentage change in price"},{"_key":"c814d16e187d","_type":"span","marks":["em"],"text":". "}],"markDefs":[],"style":"blockquote"},{"_key":"6a2423913e13","_type":"block","asset":null,"children":[{"_key":"fe53fb5acb8d","_type":"span","marks":[],"text":"The formula of "},{"_key":"5c5b3d67a919","_type":"span","marks":["strong"],"text":"PED"},{"_key":"996c6bd8a638","_type":"span","marks":[],"text":" is:"}],"markDefs":[],"style":"normal"},{"_key":"9c74fcd49998","_type":"block","asset":null,"children":[{"_key":"013a3b617a3c","_type":"span","marks":[],"text":"$$PED=\\frac{\\%\\Delta Q_d}{\\%\\Delta P}"}],"markDefs":[],"style":"normal"},{"_key":"88cba6d27f0d","_type":"block","asset":null,"children":[{"_key":"ef61852ff138","_type":"span","marks":[],"text":"Where:"}],"markDefs":[],"style":"normal"},{"_key":"c3c78abc4d7a","_type":"block","asset":null,"children":[{"_key":"547c7aae714c","_type":"span","marks":[],"text":"$\\%\\Delta Q_d = \\frac{Quantity Demanded_initial - Quantity Demanded_final}{Quantity Demanded_final} \\times 100$"}],"level":1,"listItem":"bullet","markDefs":[],"style":"normal"},{"_key":"a0d96ca57451","_type":"block","asset":null,"children":[{"_key":"be5e820687a7","_type":"span","marks":[],"text":"$\\%\\Delta P = \\frac{Price_intial - Price_final}{Price_final} \\times 100$"}],"level":1,"listItem":"bullet","markDefs":[],"style":"normal"},{"_key":"eca317021e80","_type":"block","asset":null,"children":[{"_key":"36a5bd41c6b6","_type":"span","marks":[],"text":"If we calculate the "},{"_key":"e68934a8c1da","_type":"span","marks":["strong"],"text":"PED"},{"_key":"3a531395b589","_type":"span","marks":[],"text":" for the "},{"_key":"4d651b90ce52","_type":"span","marks":["strong"],"text":"demand curve shown"},{"_key":"db24e4518c6d","_type":"span","marks":[],"text":":"}],"markDefs":[],"style":"normal"},{"_key":"10fa8c74673a","_type":"block","asset":null,"children":[{"_key":"53b53da36f3d","_type":"span","marks":[],"text":"$\\%\\Delta Q_d = \\frac{2-4} {2} \\times 100 = \\frac{-2}{2} \\times 100 = -100\\%$"}],"level":1,"listItem":"bullet","markDefs":[],"style":"normal"},{"_key":"1506b0bfbcea","_type":"block","asset":null,"children":[{"_key":"33c24c2f5eda","_type":"span","marks":[],"text":"$\\%\\Delta P = \\frac{6-3} {3} \\times 100 = \\frac{3}{3} \\times 100 = 100\\%$"}],"level":1,"listItem":"bullet","markDefs":[],"style":"normal"},{"_key":"71ee9f91ad37","_type":"block","asset":null,"children":[{"_key":"2e8fb3a3ffae","_type":"span","marks":[],"text":"Therefore, the "},{"_key":"32129c6c7027","_type":"span","marks":["strong"],"text":"PED"},{"_key":"aedf021d031e","_type":"span","marks":[],"text":" is:"}],"markDefs":[],"style":"normal"},{"_key":"42119b29dc17","_type":"block","asset":null,"children":[{"_key":"ac654367b7fa","_type":"span","marks":[],"text":"$$PED = \\frac{-100\\%} {100\\%} = -1$$"}],"markDefs":[],"style":"normal"},{"_key":"7e20a5ee7861","_type":"block","asset":null,"children":[{"_key":"00da1e091c4a","_type":"span","marks":[],"text":"As we explained, we always take the "},{"_key":"badb9cc62fe9","_type":"span","marks":["strong"],"text":"absolute value"},{"_key":"ef6660aa1dd9","_type":"span","marks":[],"text":" of the "},{"_key":"735b33e15bc1","_type":"span","marks":["strong"],"text":"PED"},{"_key":"9350ff2b1eb5","_type":"span","marks":[],"text":". Hence "},{"_key":"ae0cb88c7539","_type":"span","marks":["strong"],"text":"PED = 1"},{"_key":"4b9c7a300d9a","_type":"span","marks":[],"text":"."}],"markDefs":[],"style":"normal"},{"_key":"e4a5ce3ffde0","_type":"block","asset":null,"children":[{"_key":"e46306fd2bd6","_type":"span","marks":["strong","em"],"text":"This is because the PED is calculated as a percentage change, not as a change."}],"markDefs":[],"style":"blockquote"},{"_key":"9856f74ab5b4","_type":"block","asset":null,"children":[{"_key":"def5c1653659","_type":"span","marks":[],"text":" "}],"markDefs":[],"style":"h4"}] #### Perfectly Inelastic [7afbc3459893] 1. When $PED = 0$, the demand is called **perfectly price inelastic**. 2. Here, the percentage change in quantity demanded is always at zero regardless of what happens to the price. 3. Therefore $PED$ is 0 and the quantity demanded is **perfectly unresponsive.** #### Perfectly Elastic [82f132e36085] 1. When $PED = \infty$, the demand is called **perfectly price elastic**. 2. A small **price fall **causes people to buy an **infinite amount**, and a small **price increase** causes people to **buy nothing**. 3. Therefore $PED$ is **infinite** and the quantity demanded is **perfectly responsive.** [{"_key":"b9639d33451d","_type":"block","asset":null,"children":[{"_key":"4564db936307","_type":"span","marks":[],"text":"Why is the unit elastic demand curve curved?"}],"markDefs":[],"style":"h4"},{"_key":"9b1ee5e537f5","_type":"block","asset":null,"children":[{"_key":"69077dfd98ff0","_type":"span","marks":[],"text":"In the given "},{"_key":"69077dfd98ff1","_type":"span","marks":["strong"],"text":"unit elastic demand curve"},{"_key":"69077dfd98ff2","_type":"span","marks":[],"text":", the "},{"_key":"69077dfd98ff3","_type":"span","marks":["strong"],"text":"price elasticity of demand (PED) is equal to 1"},{"_key":"7da6cf42f84f","_type":"span","marks":[],"text":"."}],"markDefs":[],"style":"normal"},{"_key":"76d815d502ed","_type":"block","asset":null,"children":[{"_key":"bed8a8d850ab","_type":"span","marks":[],"text":"This happens when the "},{"_key":"69077dfd98ff5","_type":"span","marks":["strong"],"text":"percentage change in quantity demanded is exactly equal to the percentage change in price"},{"_key":"69077dfd98ff6","_type":"span","marks":[],"text":" at all points along the curve. Looking at the figure:"}],"markDefs":[],"style":"normal"},{"_key":"209625cebade","_type":"block","asset":null,"children":[{"_key":"03776086fd900","_type":"span","marks":[],"text":"When the price decreases from "},{"_key":"03776086fd901","_type":"span","marks":["strong"],"text":"4 to 2"},{"_key":"03776086fd902","_type":"span","marks":[],"text":" (a "},{"_key":"03776086fd903","_type":"span","marks":["strong"],"text":"50% decrease"},{"_key":"03776086fd904","_type":"span","marks":[],"text":"), the quantity demanded increases from "},{"_key":"03776086fd905","_type":"span","marks":["strong"],"text":"1 to 2"},{"_key":"03776086fd906","_type":"span","marks":[],"text":" (a "},{"_key":"03776086fd907","_type":"span","marks":["strong"],"text":"50% increase"},{"_key":"03776086fd908","_type":"span","marks":[],"text":")."}],"level":1,"listItem":"bullet","markDefs":[],"style":"normal"},{"_key":"52307039b740","_type":"block","asset":null,"children":[{"_key":"16945b29b6040","_type":"span","marks":[],"text":"Similarly, when the price falls from "},{"_key":"16945b29b6041","_type":"span","marks":["strong"],"text":"2 to 1"},{"_key":"16945b29b6042","_type":"span","marks":[],"text":" (a "},{"_key":"16945b29b6043","_type":"span","marks":["strong"],"text":"50% decrease"},{"_key":"16945b29b6044","_type":"span","marks":[],"text":"), the quantity rises from "},{"_key":"16945b29b6045","_type":"span","marks":["strong"],"text":"2 to 4"},{"_key":"16945b29b6046","_type":"span","marks":[],"text":" (a "},{"_key":"16945b29b6047","_type":"span","marks":["strong"],"text":"50% increase"},{"_key":"16945b29b6048","_type":"span","marks":[],"text":")."}],"level":1,"listItem":"bullet","markDefs":[],"style":"normal"},{"_key":"474b2f511713","_type":"block","asset":null,"children":[{"_key":"92e76527c95c0","_type":"span","marks":[],"text":"Since the "},{"_key":"92e76527c95c1","_type":"span","marks":["strong"],"text":"percentage change in quantity is equal to the percentage change in price"},{"_key":"92e76527c95c2","_type":"span","marks":[],"text":" in both cases, the "},{"_key":"92e76527c95c3","_type":"span","marks":["strong"],"text":"PED is exactly 1"},{"_key":"92e76527c95c4","_type":"span","marks":[],"text":" at all points."}],"markDefs":[],"style":"normal"}] [{"_key":"block_26","_type":"block","asset":null,"children":[{"_key":"H4lKdx2AthRpksOOBtJvl2","_type":"span","markDefs":[],"marks":[],"text":"Students often confuse PED with the slope of the demand curve. Remember, PED measures percentage changes, not the steepness of the curve."}],"markDefs":[],"style":"normal"}] ## Determinants of PED [block_39] Several factors influence how **responsive** consumers are to price changes: 1. **Number and closeness of substitutes.** 2. **Degree of necessity.** 3. **Proportion of income spent.** 4. **Time.** ### Number and Closeness of Substitutes [block_41] The more **substitutes** available, the more **elastic** the demand. * If price changes happen, people can **easily switch over** to the substitute goods. Hence, the quantity demanded is **quite **responsive_ (elastic)._ * If fewer substitutes are available, there is **not many alternatives to switch to** and therefore the quantity demanded is less responsive _(inelastic)._ [{"_key":"a0520c04dee3","_type":"block","asset":null,"children":[{"_key":"d4dabd89e74c","_type":"span","marks":[],"text":"A specific type of toothbrush has "},{"_key":"315e32501c0a","_type":"span","marks":["strong"],"text":"many substitutes"},{"_key":"972a9d5bb7a3","_type":"span","marks":[],"text":". If the prices of one noticeably increase, most people would just "},{"_key":"97ec78095997","_type":"span","marks":["strong"],"text":"switch"},{"_key":"aba84ba4c509","_type":"span","marks":[],"text":" to a cheaper one."}],"markDefs":[],"style":"normal"}] Further, it is important to know **how close** these substitutes are to each other, since they are a determining factor on whether consumers want to switch. * If two substitutes are **closer**, consumers wouldn't mind switching over. This makes the demand more elastic. * If they aren't very good substitutes of each other, consumers still **might not switch**. [{"_key":"a40e8364cbd6","_type":"block","asset":null,"children":[{"_key":"70f9af4e5fc1","_type":"span","marks":[],"text":"Sprite and 7UP are "},{"_key":"c30ec35d4f03","_type":"span","marks":["strong"],"text":"much closer"},{"_key":"ad4c192afcdb","_type":"span","marks":[],"text":" substitutes of each other "},{"_key":"ef0d81a1a598","_type":"span","marks":["strong"],"text":"than"},{"_key":"8f6e88763100","_type":"span","marks":[],"text":" Sprite and Almond Milk."}],"markDefs":[],"style":"normal"}] Another important factor is the broadness of the product. 1. If we look at **broad **categories of products (Food, Water, Coffee etc.) then they will likely have **fewer** substitutes. 2. If you focus into **narrower** products (specific type of food, brand of bottled water, a type of espresso) then they will likely have **more** **substitutes**. [{"_key":"828025af398d","_type":"block","asset":null,"children":[{"_key":"6cca70a34c1a","_type":"span","marks":[],"text":"A specific type of coffee has "},{"_key":"5d8d0cf946d1","_type":"span","marks":["strong"],"text":"more substitutes"},{"_key":"da4182e5b4cc","_type":"span","marks":[],"text":" (other types of coffee)"}],"level":1,"listItem":"bullet","markDefs":[],"style":"normal"},{"_key":"26155c8a2d4f","_type":"block","asset":null,"children":[{"_key":"9cdf362621f7","_type":"span","marks":[],"text":"Coffee itself "},{"_key":"3cc73fb638ae","_type":"span","marks":["strong"],"text":"doesn't "},{"_key":"416efc2f4a24","_type":"span","marks":[],"text":"have many (maybe tea)"}],"level":1,"listItem":"bullet","markDefs":[],"style":"normal"},{"_key":"8da34e256eb0","_type":"block","asset":null,"children":[{"_key":"9634f254dab5","_type":"span","marks":[],"text":"A drink "},{"_key":"081b0c74bb6c","_type":"span","marks":["em"],"text":"technically"},{"_key":"188f2f848781","_type":"span","marks":[],"text":" has none (you have to drink something!)"}],"level":1,"listItem":"bullet","markDefs":[],"style":"normal"}] ### Degree of Necessity [block_43] Goods or services **crucial** for ones' life and extremely difficult to live without. Goods and services that are **not essential** for one's living and often bought for leisure purposes. Necessities tend to have** inelastic** demand, as consumers cannot easily **reduce** consumption. Luxuries, on the other hand, have **elastic** demand. [{"_key":"block_46","_type":"block","asset":null,"children":[{"_key":"H4lKdx2AthRpksOOBtJvv8","_type":"span","markDefs":[],"marks":[],"text":"Demand for food (a necessity) is "},{"_key":"de0deac5698b","_type":"span","markDefs":[],"marks":["strong"],"text":"less"},{"_key":"5e57aa13b104","_type":"span","markDefs":[],"marks":[],"text":" "},{"_key":"46b50876a2ae","_type":"span","markDefs":[],"marks":["strong"],"text":"elastic"},{"_key":"ddea6e934bf1","_type":"span","markDefs":[],"marks":[],"text":" than demand for high-end hand bags (a luxury)."}],"markDefs":[],"style":"normal"},{"_key":"23136a5dc384","_type":"block","asset":null,"children":[{"_key":"e74582a78f57","_type":"span","markDefs":[],"marks":[],"text":"If the price of food "},{"_key":"1e78c322def6","_type":"span","markDefs":[],"marks":["strong"],"text":"increases"},{"_key":"ea252bd92f9f","_type":"span","markDefs":[],"marks":[],"text":", people will "},{"_key":"f4fe5fbc9e99","_type":"span","markDefs":[],"marks":["strong"],"text":"still need"},{"_key":"3fdcf573cd67","_type":"span","markDefs":[],"marks":[],"text":" to buy it to eat and survive. If it "},{"_key":"4201363723f5","_type":"span","markDefs":[],"marks":["strong"],"text":"decreases"},{"_key":"4ecfda4994f7","_type":"span","markDefs":[],"marks":[],"text":", people don't just magically start eating more."}],"markDefs":[],"style":"normal"}] #### Addictive Goods [b917484484dc] A unique case of **necessity goods** are those that people get addicted to. Even though it might not be a good they need physically, **their addiction** demands it. * People can get **addicted **to goods and services like cigarettes, alcohol, gambling and many more. * Even though these aren't crucial for living, it is hard for people to **change their spending patterns** even if the price rises due to their **addiction**. ### Proportion of Income Spent [block_47] Goods that take up a **large share** of income (e.g., cars) tend to have **elastic** demand, while **inexpensive** items (e.g., chewing gum) are **inelastic**. * If the price percentage **increases** by a lot, people might **not be able to** buy a car while chewing gum prices **won't affect **them much. * If the price percentage **falls**, **more people** might demand cars or luxury cars while people **won't just buy** more chewing gum. 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[{"_key":"12a4e24f418d","_type":"block","asset":null,"children":[{"_key":"c0392f82f596","_type":"span","marks":[],"text":"If a person has "},{"_key":"422a76652a64","_type":"span","marks":["strong"],"text":"a lot of time "},{"_key":"7ab4f7669eb2","_type":"span","marks":[],"text":"when given a choice to buy a car, they will consider all "},{"_key":"0d2b28e1fe2c","_type":"span","marks":["strong"],"text":"alternatives"},{"_key":"47f5e6b987c4","_type":"span","marks":[],"text":" making them switch to the better option if the price rises."}],"markDefs":[],"style":"normal"},{"_key":"7f114cc3e5e0","_type":"block","asset":null,"children":[{"_key":"61c8634c9ad1","_type":"span","marks":[],"text":""}],"markDefs":[],"style":"normal"},{"_key":"70ef717390d5","_type":"block","asset":null,"children":[{"_key":"8fcc4c92d3bc","_type":"span","marks":[],"text":"However if they have to make a decision in a hurry, they "},{"_key":"b6cc87dfd1bf","_type":"span","marks":["strong"],"text":"might not know"},{"_key":"4074df9548d6","_type":"span","marks":[],"text":" the other alternatives or choices and "},{"_key":"8c3d9c160a69","_type":"span","marks":["strong"],"text":"impulsively"},{"_key":"94575a58ee86","_type":"span","marks":[],"text":" buy, making their demand inelastic."}],"markDefs":[],"style":"normal"}] ## PED and Total Revenue [block_53] Amount of **money received** by firms when they sell a good (or service). Total revenue is calculated as: $$\text{TR} = \text{Price} \times \text{Quantity Sold}$$ 1. Different increases in $P$ lead to different decreases in $Q$, so the effect on **total revenue** will depend upon the **elasticity** **of** **demand**. 2. As a result, understanding how to price their goods and services helps firms to increase their revenue. #### Price Inelastic Demand (PED < 1) [76fb1a6d45df] When demand is **inelastic**, raising prices **increases** total revenue and **decreasing** prices causes total revenue to** fall.** 1. **Total revenue increases** because the percentage drop in quantity demanded is **smaller **than the percentage increase in price. 2. **Total revenue decreases** because the percentage increase in quantity demanded is **smaller **than the percentage decrease in price. 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figure above shows the points along the demand curve with: $P_1 = 10, P_2 = 15$ and $P_3 = 5$ alongside $Q_1 = 100, Q_2 = 75$ and $Q_3 = 125$."}],"markDefs":[],"style":"normal"},{"_key":"1ad7cc9c5894","_type":"block","asset":null,"children":[{"_key":"780f39bfec9f","_type":"span","marks":[],"text":"At point $P_1$, whether we move up or down the curve, the demand is "},{"_key":"15ba2c9587f5","_type":"span","marks":["strong"],"text":"inelastic"},{"_key":"805bb678e0ae","_type":"span","marks":[],"text":" "},{"_key":"d9969d6d1681","_type":"span","marks":["em"],"text":"(verify yourself)."}],"markDefs":[],"style":"normal"},{"_key":"71dbae404aa9","_type":"block","asset":null,"children":[{"_key":"3bfa0b4ab544","_type":"span","marks":[],"text":"The"},{"_key":"05c03d8cee0c","_type":"span","marks":["strong"],"text":" total revenue"},{"_key":"b67d248c95f5","_type":"span","marks":[],"text":" at $(P_1,Q_1)$ is:"}],"markDefs":[],"style":"normal"},{"_key":"2eb268ac0fb0","_type":"block","asset":null,"children":[{"_key":"9e90fe553f07","_type":"span","marks":[],"text":"$$ TR = 10 \\times 100 = \\$ 1000 $$"}],"markDefs":[],"style":"normal"},{"_key":"f07472cd73ad","_type":"block","asset":null,"children":[{"_key":"e2a661b06eb9","_type":"span","marks":[],"text":"If the price increases to $P_2$ then total revenue will also increase to $P_2Q_2=15\\times 75=\\$ 1125$."}],"level":1,"listItem":"number","markDefs":[],"style":"normal"},{"_key":"522a7183a47e","_type":"block","asset":null,"children":[{"_key":"26d3c8766509","_type":"span","marks":[],"text":"If the price decreases to $P_3$ then the total revenue will also decrease to $P_3Q_3 = 5 \\times 125 = \\$ 625$."}],"level":1,"listItem":"number","markDefs":[],"style":"normal"},{"_key":"f0861cbe4fc8","_type":"block","asset":null,"children":[{"_key":"f6927452df65","_type":"span","marks":[],"text":""}],"markDefs":[],"style":"normal"},{"_key":"54c7b373c8ef","_type":"block","asset":null,"children":[{"_key":"68838953ea71","_type":"span","marks":["em"],"text":""}],"markDefs":[],"style":"normal"},{"_key":"7f5d681fd5ee","_type":"block","asset":null,"children":[{"_key":"12f3ae3dc019","_type":"span","marks":["em"],"text":""}],"markDefs":[],"style":"normal"}] #### Price Elastic Demand (PED > 1) [block_59] When demand is **elastic**, raising prices **decreases** total revenue and **decreasing** prices causes total revenue to** increase.** 1. **Total revenue decreases** because the percentage drop in quantity demanded is **larger **than the percentage increase in price. 2. **Total revenue increases** because the percentage increase in quantity demanded is **larger **than the percentage decrease in price. 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figure above shows the points along the demand curve with $P_1 = 10, P_2 = 12.5$ and $P_3 = 7.5$ alongside $Q_1 = 100, Q_2 = 50$ and $Q_3 = 150$."}],"markDefs":[],"style":"normal"},{"_key":"1ad7cc9c5894","_type":"block","asset":null,"children":[{"_key":"780f39bfec9f","_type":"span","marks":[],"text":"At the point $P_1$, whether we go up or down the curve, the demand is "},{"_key":"15ba2c9587f5","_type":"span","marks":["strong"],"text":"elastic"},{"_key":"805bb678e0ae","_type":"span","marks":[],"text":" "},{"_key":"d9969d6d1681","_type":"span","marks":["em"],"text":"(verify yourself)."}],"markDefs":[],"style":"normal"},{"_key":"71dbae404aa9","_type":"block","asset":null,"children":[{"_key":"3bfa0b4ab544","_type":"span","marks":[],"text":"The"},{"_key":"05c03d8cee0c","_type":"span","marks":["strong"],"text":" total revenue"},{"_key":"b67d248c95f5","_type":"span","marks":[],"text":" at $(P_1,Q_1)$ is:"}],"markDefs":[],"style":"normal"},{"_key":"2eb268ac0fb0","_type":"block","asset":null,"children":[{"_key":"9e90fe553f07","_type":"span","marks":[],"text":"$$ TR = 10 \\times 100 = \\$ 1000 $$"}],"markDefs":[],"style":"normal"},{"_key":"f07472cd73ad","_type":"block","asset":null,"children":[{"_key":"e2a661b06eb9","_type":"span","marks":[],"text":"If the price increases to $P_2$ then total revenue will decrease to $P_2Q_2=12.5\\times 50=\\$ 625$."}],"level":1,"listItem":"number","markDefs":[],"style":"normal"},{"_key":"522a7183a47e","_type":"block","asset":null,"children":[{"_key":"26d3c8766509","_type":"span","marks":[],"text":"If the price decreases to $P_3$ then the total revenue will increase to $P_3Q_3 = 7.5 \\times 150 = \\$ 1150$."}],"level":1,"listItem":"number","markDefs":[],"style":"normal"},{"_key":"f0861cbe4fc8","_type":"block","asset":null,"children":[{"_key":"f6927452df65","_type":"span","marks":[],"text":""}],"markDefs":[],"style":"normal"},{"_key":"54c7b373c8ef","_type":"block","asset":null,"children":[{"_key":"68838953ea71","_type":"span","marks":["em"],"text":""}],"markDefs":[],"style":"normal"},{"_key":"7f5d681fd5ee","_type":"block","asset":null,"children":[{"_key":"12f3ae3dc019","_type":"span","marks":["em"],"text":""}],"markDefs":[],"style":"normal"}] #### Unit Elastic Demand (PED = 1) [22d2193f8a52] When demand is **unit elastic **throughout the entire demand curve, changing prices doesn't affect total revenue. 1. **Total revenue doesn't change** because the percentage change in quantity demanded is **the same as** the percentage change in price. ## Changing PED Along a Linear Demand Curve (HL Only) [block_64] On a **straight-line downward-sloping** demand curve, PED varies along its length: ![](https://cdn.sanity.io/images/w7j7fz60/production/9fa3b31f512a47733401960f663465ecc390124e-2400x1861.png) As observed in the figure above, for **higher prices** and **lower quantities**, the demand is **elastic** while for **lower prices** and **higher quantities**, it is **inelastic**. 1. At high prices (low quantities), a change in price is **worth a lower percentage** of price, and a change in quantity is **worth a higher percentage** of quantity. 2. This can be seen by high prices (lower quantities) leading to a** smaller **$\frac{\Delta P}{P}$ since the **denominator is big.** 3. And a **higher** $\frac{\Delta Q}{Q}$ since the **denominator is small.** 4. Therefore the **responsiveness** of quantity demanded to price is** high** and the demand is **elastic**. The argument follows **similarly** for low prices (high quantities) 1. At low prices (higher quantities), a change in price is **worth a higher percentage** of price, and a change in quantity is **worth a lower percentage** of quantity. 2. This can be seen by low prices (higher quantities) leading to a** larger **$\frac{\Delta P}{P}$ since the **denominator is small.** 3. And a **lower** $\frac{\Delta Q}{Q}$ since the **denominator is big.** 4. Therefore the **responsiveness** of quantity demanded to price is** low** and the demand is **inelastic**. #### Mathematical Derivation [da4816fb2651] We can rewrite the elasticity function as: $$ PED = \frac{\frac{\Delta Q}{Q}}{\frac{\Delta P}{P}} = \frac{\Delta Q}{\Delta P}\times \frac{P}{Q} = \frac{1}{\frac{\Delta P}{\Delta Q}}\times \frac{P}{Q} = \frac{1}{slope} \times \frac{P}{Q}$$ Where $\frac{\Delta P}{\Delta Q}$ is the slope because $P$ is the $y$-axis and $Q$ is the $x$-axis allowing us to use $\frac{rise}{run}$ since we are focusing on a **straight line**. The slope is **constant** for a straight line hence the only variable is $\frac{P}{Q}$. 1. For **higher prices,** $\frac{P}{Q}$ is larger, and so more elastic. 2. For **lower prices,** $\frac{P}{Q}$ is smaller, and so more inelastic. [{"_key":"block_72","_type":"block","asset":null,"children":[{"_key":"H4lKdx2AthRpksOOBtJwKN","_type":"span","markDefs":[],"marks":[],"text":"Even though the "},{"_key":"ab077de4dd7f","_type":"span","markDefs":[],"marks":["strong"],"text":"slope"},{"_key":"5c134bc4651d","_type":"span","markDefs":[],"marks":[],"text":" of a linear demand curve is "},{"_key":"77e0df6e5d8e","_type":"span","markDefs":[],"marks":["strong"],"text":"constant"},{"_key":"7b6b57b6b44c","_type":"span","markDefs":[],"marks":[],"text":", "},{"_key":"04c50cba237c","_type":"span","markDefs":[],"marks":["strong"],"text":"PED"},{"_key":"604575d6add9","_type":"span","markDefs":[],"marks":[],"text":" changes because it depends on "},{"_key":"dd4a9dcf5ff6","_type":"span","markDefs":[],"marks":["strong"],"text":"percentage"},{"_key":"20721db4f4f6","_type":"span","markDefs":[],"marks":[],"text":" changes, not "},{"_key":"29820cf12752","_type":"span","markDefs":[],"marks":["strong"],"text":"absolute"},{"_key":"2ed324ba8b22","_type":"span","markDefs":[],"marks":[],"text":" changes."}],"markDefs":[],"style":"normal"}] [{"_key":"cefc60098fa1","_type":"block","asset":null,"children":[{"_key":"16bf4e5637e1","_type":"span","markDefs":[],"marks":[],"text":"Why do you think necessities like water have inelastic demand, while luxuries like vacations have elastic demand?"}],"level":1,"listItem":"bullet","markDefs":[],"style":"normal"},{"_key":"603ecae19343","_type":"block","asset":null,"children":[{"_key":"ab1d2a2e2de3","_type":"span","markDefs":[],"marks":[],"text":"How might cultural differences influence the elasticity of demand for certain goods?"}],"level":1,"listItem":"bullet","markDefs":[],"style":"normal"},{"_key":"59783fd2bb5b","_type":"block","asset":null,"children":[{"_key":"5e7d85316eed","_type":"span","markDefs":[],"marks":[],"text":"To what extent can firms manipulate PED through marketing or product differentiation?"}],"level":1,"listItem":"bullet","markDefs":[],"style":"normal"}] [{"_key":"block_79","_type":"block","asset":null,"children":[{"_key":"H4lKdx2AthRpksOOBtJwPQ","_type":"span","markDefs":[],"marks":[],"text":"Can you explain what might affect the PED of a good and showcase the different PEDs on a graph?"}],"markDefs":[],"style":"normal"}] The following figure shows the demand curve in the market of **cigarettes**. ![](https://cdn.sanity.io/images/w7j7fz60/production/84b295cf471fffa3f56ce3e7dcf3e9d4cb08690a-2338x1813.png) 1. **Define** price elasticity of demand. _[2 marks]_ 2. **Calculate** the price elasticity of demand at the price of $5$. _[3 marks]_ 3. Using your answer to part (2), **explain** why the demand might be facing this elasticity. _[4 marks]_ 1. A measure of the responsiveness of quantity demanded _(1 mark) _when there is a change in price. _(1 mark)_ 2. Calculate percentage change in $Q$ $$ \%\Delta Q = \frac{20-25}{25} \times 100 = \frac{-5}{25} \times 100 = -20\% $$ Calculate percentage change in $P$ $$ \%\Delta P = \frac{10-5}{5} \times 100 = 100\%$$ Calculate PED $$ PED = \frac{-20}{100} = \frac{-1}{5} $$ 3. The elasticity found in part (2) shows that at $P=5$, hence the demand is inelastic _(1 mark). _Cigarettes are addictive goods _(1 mark) _and therefore even with substantial price increases, the quantity demanded will not fall significantly as consumers cannot change their consumption due to their addiction _(1 mark). _They may also be a small part of income for many consumers. _(1 mark) _For the last (1 mark), student can give any other reason including: - Fewer Substitutes - Psychological Factors - Any other valid factor