2.4.1 Definition, Calculation & Determinants of PED

The Definition & Calculation of PED

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

$PED = \frac{% change in quantity demanded}{% change in price} = \frac{% △ in QD}{% △ in P}$

To calculate a % change, use the following formula

$% C hange = \frac{new value - old value}{old value} \times 100$

Worked Example

A firm raises the price of its products from $10 to $15. Its sales fall from 100 to 40 units per day. Calculate the PED of its products [2]

Step 1: Calculate the % change in QD

$% △ QD = \frac{40 - 100}{100} \times 100 % △ QD = - 60 %$

Step 2: Calculate the % change in P

$% △ P = \frac{15 - 10}{10} x 100 % △ P = 50 %$

Step 3: Insert the above values in the PED formula

$PED = \frac{% △ in QD}{% △ in P} PED = \frac{- 60}{50} PED = - 1.2$

Step 4: Final answer = 1.2

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

(Two marks for the correct answer or 1 mark for any correct working in the process)

Exam Tip

In Paper 2 you are occasionally given the PED value and the %Δ in QD - you are then asked to calculate the %Δ in price. Follow the standard math procedure as follows:

1. Substitute the values provided into the equation

2. Substitute X for %Δ in price

3. Solve for X

Interpreting PED Values

The size of PED Varies from 0 to Infinity (∞) and is Classified as Follows

Value	Name	Explanation	Diagram
0	Perfectly Inelastic	The QD is completely unresponsive to a change in P (very theoretical value e.g. heart transplant is extremely inelastic but possibly not perfectly)
0→1	Relatively Inelastic	The %∆ in QD is less than proportional to the %∆ in P (e.g. addictive products)
1	Unitary Elasticity	The % ∆ in QD is exactly equal to the %∆ in P
1→ ∞	Relatively Elastic	The %∆ in QD is more than proportional to the %∆ in P (e.g. luxury products)
∞	Perfectly Elastic	The %∆ in QD will fall to zero with any %∆ in P (highly theoretical elasticity)