Price Elasticity of Demand (PED) refers to the percentage change in the quantity demanded of a good or service resulting from a percentage change in its price. In simple terms, it measures how much the demand for a product increases or decreases when its price changes.

When the price of a product changes, the demand for that product can either increase or decrease, depending on the elasticity of the product. The degree of this responsiveness is determined by the price elasticity of demand.

Types of Demand: Elastic vs. Inelastic

The demand for a product can be categorized as either elastic or inelastic:

• Elastic Demand: When the demand for a product changes by a greater proportion than the price change, it is considered elastic. In other words, a small change in price leads to a large change in demand.

• Inelastic Demand: When the change in demand is smaller than the change in price, the demand is inelastic. This means that even with a significant price change, the quantity demanded doesn’t change much.

The Slope of the Demand Curve and PED

The price elasticity of demand is represented by the slope of the demand curve. Here’s how it works:

• Elastic Demand: A steep demand curve indicates that a small change in price results in a large change in demand.

• Inelastic Demand: A flatter demand curve indicates that changes in price have a minimal effect on demand.

Formula for Price Elasticity of Demand (PED)

The price elasticity of demand can be mathematically expressed as:

PED=%ΔQd / %ΔP

Where:

• % Δ Q_d = Percentage change in the quantity demanded

• % Δ P = Percentage change in price

The PED is typically negative because price and demand are inversely related (i.e., as price increases, demand decreases and vice versa).

Interpreting the Value of PED

• PED < 1: Demand is inelastic, meaning the quantity demanded changes less than the price change.

• PED > 1: Demand is elastic, meaning the quantity demanded changes more than the price change.

• PED = 1: Demand is unitary elastic, meaning the change in demand is exactly proportional to the price change.

Importance of Price Elasticity of Demand

Understanding PED helps businesses and policymakers make informed decisions about pricing strategies:

• Pricing Decisions: If demand is elastic, lowering prices could increase total revenue. If demand is inelastic, businesses might raise prices without significantly affecting demand.

• Revenue Forecasting: Knowing the elasticity of demand allows businesses to predict how changes in price will impact their sales and revenue.

• Taxation and Subsidies: Governments use PED to assess the impact of taxes and subsidies on goods and services.