Economic factors affect and respond to each other in different ways:
- Quantity demanded responds inversely to the change in price (law of demand).
- Quantity supplied responds positively to the change in price (law of supply).
This section's new concept, elasticity, focuses on measuring this responsiveness.
Price Elasticity of Demand
Price Elasticity of Demand (PED)
A measure of the responsiveness of quantity demanded when there is a price change.
According to its price elasticity, the demand for goods and services can be categorised into:
- Relatively elastic demand.
- Relatively inelastic demand.
- Unitary elastic demand.
- Perfectly elastic demand.
- Perfectly inelastic demand.
Relatively Elastic Demand
When demand is relatively elastic, consumers are highly responsive to price changes.
- A small change in price causes a large change in the quantity demanded.
- The PED is also higher than 1.
Think of a good with a lot of substitutes like a specific brand of coffee:
- If the price of that brand of coffee rises by even a little bit, people will switch to substitutes
- Hence the quantity demanded of that one good will fall by a lot.
Note: The argument "What if people don't switch because they just like that brand of coffee more or are loyal to it" does not hold because:
- If we assume the brand of coffee has substitutes then they value the other coffee brands as much as this one.
- If they like this coffee brand or are loyal to it then the assumption of having substitutes wouldn't hold.
Relatively Inelastic Demand
When demand is relatively inelastic, consumers are less responsive to price changes.
- Even large deviations in price don't result in much of a change in the quantity demanded
- The PED is lower than 1.
Now think of coffee as a whole:
- While individual brands of coffee have other brands as substitutes, coffee itself doesn't (we assume tea is still different in this case)
- Or other goods like necessities such as water, milk, food etc.
If the prices of these goods rises, even by a lot, their quantity demanded won't fall by much because:
- People cannot easily switch to something else, since there are no substitutes
- People still need things like food, water and other necessities to survive.
An interesting fact is while the general goods (like water) might be inelastic, individual brands of that good (brands of bottled water) might be elastic.
Elastic and Inelastic Demand Curves
On the other hand, the Figure 3 above shows the demand curve of a good that has a high PED or in other words, is elastic.
- There is a higher decline in quantity demanded compared to the change in price.
- Therefore, the curve is relatively flatter.
The figure above shows the demand curve of a good that has a low PED or in other words, is inelastic.
- There is a lower decline in quantity demanded compared to the change in price.
- Therefore, the curve is relatively steeper.
Hence, the responsiveness of quantity is measured based on the percentage change of quantity demanded against the percentage change in price.
Usually, the flatter curve represents a high elasticity and the curve that is steeper represents a low elasticity (inelasticity)
Common MistakeThe above is true if both the curves intercept on the same set of axis
- If you have 2 different demand curves that are drawn on 2 different axis, then you cannot just visually say that the flatter one is elastic!
- 2 different axes can have different scaling and values, therefore you cannot compare different demand curves drawn on separate graphs.
If 2 different demand curves intercept on the same graph or axis, then the flatter one is always more elastic at every point.
Theory of KnowledgeHow might cultural differences or local contexts affect the elasticity of demand for certain goods? For example, would the demand for rice be more inelastic in countries where it is a staple food?
Self review- Can you identify a product in your daily life that has price elastic demand? What about a product with price inelastic demand?
- How could firms use knowledge of PED to adjust their pricing strategies during an economic downturn?
- Are there ethical considerations for governments when taxing price inelastic goods like medications or fuel?
