Calculation & Determinants of PED (Cambridge International IGCSE Economics)

Introducing price elasticity of demand

Spec point — 2.6.1 · Definition of PED; Calculation of PED

• The law of demand states that when there is an increase in price, there will be a fall in quantity demanded

  • Economists are interested by how much the quantity demanded will fall

• Price elasticity of demand reveals how responsive the change in quantity demanded is to a change in price

  • The responsiveness is different for different types of products

Calculation of PED

• PED can be calculated using the following formula:

$\text{PED = } \frac{\% \text{change} \text{in} \text{quantity} demanded}{\% \text{change} \text{in} price} = \frac{\% \Delta \text{in} QD}{\% \Delta \text{in} \mathrm{P} }$

• To calculate a % change, use the following formula:

$\% \text{Change} = \frac{new \text{value} - \text{old} value}{old value} \times 100$

Worked Example A firm raises the price of one of its products from £10 to £15. Its sales fall from 100 to 40 units per day. Calculate the PED of this product

Step 1: Calculate the % change in QD

**$% \Delta \text{QD} = \frac{40 - 100}{100} \times 100

% \Delta \text{QD} = - 60 %$** (1 mark)

Step 2: Calculate the % change in P

$% \Delta \mathrm{P} = \frac{15 - 10}{10} \mathrm{x} 100

% \Delta \mathrm{P} = 50 %$ (1 mark)

Step 3: Insert the above values in the PED formula

$\text{PED} = \frac{% \Delta \text{in} QD}{% \Delta \text{in} \mathrm{P} }

\text{PED} = \frac{- 60}{ 50}

\text{PED} = - 1.2 $ (2 marks)

The PED value will always be negative so economists will often ignore the sign and present the answer as 1.2

Drawing and interpreting PED values

Spec point — "Drawing and interpreting PED values: perfectly inelastic, inelastic, unitary, elastic, perfectly elastic; Drawing and interpreting demand curve diagrams to show different PED"

Drawing and interpreting PED values

• The results of the price elasticity of demand calculation tell us how responsive consumers are to a change in price

1. Price elastic demand

• The value of PED: 1 → ∞
• The percentage change in quantity demanded is more than proportional to the percentage change in price

Consumers are very responsive to price changes

• Consumers are very responsive to price changes

  • For example, a small price cut on airline tickets in Malaysia can lead to a large rise in bookings

2. Price inelastic demand

• The value of PED: 0 → 1
• The percentage change in quantity demanded is less than proportional to the percentage change in price

Price inelastic demand

• Consumers are relatively unresponsive to price changes

  • They may consider the product to be a necessity

• For example, cigarette sales in Indonesia fall only slightly when prices rise – demand is inelastic

3. Perfectly elastic demand

• The value of PED: ∞
• The quantity demanded will fall to zero with any percentage change in price (highly theoretical elasticity)

Perfectly elastic demand

• Buyers will only purchase at one price, and any change causes demand to drop to zero
• For example, on global stock markets, traders may only buy a share at a specific price, not higher

4. Perfectly inelastic demand

• The value of PED: 0
• The quantity demanded is completely unresponsive to a change in price (very theoretical value)

Consumers are entirely unresponsive to a change in price

• For example, a patient needing life-saving insulin in India will buy it regardless of price

5. Unitary elasticity

• The value of PED: 1
• The percentage change in quantity demanded is exactly equal to the percentage change in price

Consumer respond proportionally to any price changes

• A 5% rise in the price of a basic mobile plan in Egypt causes a 5% drop in subscriptions

The determinants of PED

Spec point — 2.6.3 · main influences on whether demand is elastic or inelastic

• Some products are more responsive to changes in prices than other products
• The factors that determine responsiveness are called the determinants of PED and include

SPLAT - An acronym to help recall the determinants of PED

S – Availability of substitutes

• Good availability of substitutes results in a higher value of PED (relatively elastic)

P – Price of product as a proportion of income

• The lower the proportion of income the price represents, the lower the PED value will be
• Consumers are less responsive to price changes on cheap products (relatively inelastic)

L – Luxury or necessity

• Luxury goods are more elastic because they are not essential, while necessities are more inelastic because consumers have no choice but to buy them.

A - Addictiveness of the product

• Addictiveness turns products into necessities, resulting in a low value of PED (relatively inelastic)

T – Time period

• In the short term, consumers are less responsive to price increases, resulting in a low value of PED(relatively inelastic)
• Over a longer period of time, consumers may feel the price increase more and will then look for substitutes, resulting in a higher value of PED (relatively elastic)