2.2 PED

It is a measure of how much the quantity demanded of a product changes when there is a change in the price of the product. It is the absolute value of the percentage change in quantity demanded, over the percentage change in price.

Possible range of values

Value of PED	Demand	Interpretation
Between 0 and 1	Inelastic	Quantity demanded is relatively unresponsive to price
Greater than 1	Elastic	Quantity demanded is relatively responsive to price
1	Unit elastic	Change in price causes an equal change in demand
0	Perfectly inelastic	Quantity demanded is completely unresponsive to price
Infinity	Perfectly elastic	Quantity demanded is completely responsive to price

Varying elasticity along a straight-line D curve

On any straight line demand curve, there is an elastic portion at high prices, and an inelastic portion at low prices. The midpoint of a curve is unit elastic demand. This arises simply from arithmatics.

However, in practice, if the price of an expencive good increases, then the real income will decrease even further, leading to a relative elastic demand. In the case of a cheaper good, the demand is already at a large quantity. Due to the law of diminishing marginal utility, purchasing one more unit of the good is not in question. Therefore, demand is inelastic at low prices.

Talking about graphs, it is important to note that PED is only comparable if the two curves intersect. If they are parralel, the curve which has the highest point of unit elasticity (PED=1), has the highest PED.

Total Revenue (TR=PxQ)
An increase in price of a good which has ineastic demand will increase TR.


Determinants of PED
Number and closeness of substitues - demand will be inelastic if consumers have no choice but to buy that one good.
Necessity of the product - food has inelastic demand, however, the more specified the product is, the less inelastic is the demand.
Time period considered - in the short-run, demand is likely to be inelastic.

Applications of PED

Total Revenue (TR=PxQ)

An increase in price of a good which has ineastic demand will increase TR, while it will decrease if demand is elastic. If the demand is unit elastic, a change in price does nto cause any change in total revenue. This links with the firm's decision to change price. It is impossible to predict the effect on profit as total costs may increase faster than total revenue.

Indirect taxes

May be imposed on goods with inelastic demand in order to increase tax revenues.