Price elasticity of demand measures the responsiveness of quantity demanded to changes in price.
## Core concept
Price elasticity of demand (PED) quantifies how sensitive consumers are to price changes. It answers: "If price rises by 1%, how much does quantity demanded fall?"
- Definition: The percentage change in quantity demanded divided by the percentage change in price.
- Formula: PED = (% change in QD) / (% change in Price) = (ΔQD/QD) / (ΔP/P)
- Interpretation: PED is always negative (inverse relationship between price and QD per Law of Demand), but economists often report absolute values.
## Types of price elasticity
| Elasticity | PED value | Meaning | Example | |---|---|---|---| | Elastic | \|PED\| > 1 | QD is very responsive to price change | Luxury goods, salt substitute | | Unit elastic | \|PED\| = 1 | % change in QD = % change in price | Rare in reality | | Inelastic | \|PED\| < 1 | QD is weakly responsive to price change | Essential goods (salt, medicine) | | Perfectly elastic | PED = ∞ | Even tiny price rise → QD = 0 | Perfectly competitive goods | | Perfectly inelastic | PED = 0 | QD unchanged regardless of price | Insulin for diabetics |
## Determinants of price elasticity
- Number of substitutes: More substitutes → more elastic (consumers switch easily).
- Necessity vs luxury: Luxuries are elastic; necessities are inelastic.
- Proportion of income spent: Higher share → more elastic (price changes hurt more).
- Time horizon: Longer term → more elastic (consumers adapt); short term → inelastic.
- Brand loyalty: Strong loyalty → inelastic.
## Worked example
A bookstore sells novels. When price is ₹400/book, 200 books are sold monthly. Price rises to ₹500/book; sales drop to 150 books.
Calculate PED: - ΔQD = 150 − 200 = −50 - ΔP = 500 − 400 = 100 - PED = (−50/200) / (100/400) = (−0.25) / (0.25) = −1.0 (unit elastic)
Interpretation: A 1% price increase causes a 1% decrease in quantity demanded. Revenue remains unchanged (both at ₹80,000).
## Common exam applications
- Pricing decisions: Firms with elastic demand benefit from lower prices (higher revenue). Inelastic demand allows price increases.
- Revenue impact:
- - Elastic demand: Price ↑ → Revenue ↓
- - Inelastic demand: Price ↑ → Revenue ↑
- Tax incidence: Inelastic goods (cigarettes, alcohol) bear higher tax burden because consumption doesn't fall much.
- Distinguish from income elasticity: PED measures price sensitivity; income elasticity (Section 4 of economics syllabi) measures income sensitivity.
## Common mistakes
- Sign confusion: Reporting PED as positive when it's mathematically negative. Report absolute value in exams unless asked for signed value.
- Percentage vs absolute change: Always convert to percentages; absolute changes are meaningless across different units.
- Confusing elasticity types: "Elastic" means |PED| > 1 (quantity very responsive); "inelastic" means |PED| < 1 (quantity weakly responsive).
- Static vs dynamic: Exam questions may ask about short-term vs long-term elasticity; always specify the time frame.
- Movement vs shift confusion: PED describes movement *along* the demand curve (price change); demand shift (from determinants) is separate.
## Quick checklist for exam answers
✓ State the formula clearly ✓ Show calculation step-by-step ✓ Interpret the elasticity value (elastic/inelastic) ✓ Link to real-world implication (revenue, tax, pricing) ✓ Use absolute values unless sign is specifically requested