Price Elasticity of Demand (PED)

🌱September 28, 2021.
Last tended May 21, 2022.
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1 minute read ⏱

Price Elasticity of Demand (PED) is a useful microeconomics tool to help quantify changes in supply and demand. PED is used to mathematically measure price elasticity.

The equation to calculate PED is: PED=(% change in Quantity demanded)/(% change in Price).

Using the equation for PED helps analyze price elasticity. This is because PED makes analysis of demand change precise.

When demand is elastic, the % change in Quantity demanded is not equal to the % change in Price; it’s greater.

When demand is inelastic, the % change in Quantity demanded is not the same as the % change in Price; it’s less.

To calculate the change in Quantity, use the midpoint method. Consider the following demand table:

Price (P) Quantity Demanded (Q)
$5 100
$6 90
$7 85
$8 60
$9 40
$10 5

Let’s calculate the % change in Quantity demanded when the price changes from 6 to 7 dollars using the midpoint method. Use this formula to calculate the % change: Q2βˆ’Q1Q2+Q12\frac{Q2-Q1}{\frac{Q2+Q1}{2}}. In friendlier terms, for two price points it’s the difference in demand divided by the average (mean) demand of those prices.

Using the data from our demand table, the equation looks like this: 85βˆ’9085+902=βˆ’51752=βˆ’5.7\frac{85-90}{\frac{85+90}{2}}=\frac{-5}{\frac{175}{2}}=-5.7%

When calculating the percent change for Price Elasticity of Demand (PED), it’s not important whether it’s a positive or negative percentage. We only need the absolute value.

The same formula is used for calculating changes in price. For the demand table above, this would be: ($7-$6)/(($7+$6)/2) => $1/($6.5) => ~15.4%.

Bringing this all together, PED = 5.7%/15.4% => 0.37. The PED is less than 1 because the % change in price is greater than the % change in quantity.

When PED is less than 1 it means demand is inelastic.

When the % change in price and quantity are equal, the movement between those price points is unit elastic.

When a change in price is unit elastic, the PED is exactly 1.

If the Price elasticity of demand is greater than 1, the demand is elastic.

Some goods don’t respond to price changes at all. Consider insulin, the medicine used by people with diabetes to regulate blood sugar. Without it, they die. When the price changes, demand stays constant. Goods with PED=0PED = 0 are perfectly inelastic.

The change in PED tends to correlate with the slope of a demand curve. The slope of the curve is not the same as PED, but can also be used as an indicator of price elasticity. The demand curve of perfectly inelastic goods is a vertical line - the quantity demanded is constant regardless of price.