Price Elasticity of Demand (PED)

Definition

Price Elasticity of Demand (PED) is a measure of the responsiveness of the quantity demanded of a good or service to changes in its price. It quantifies the degree to which the demand for a product changes when its price changes, allowing economists to understand and predict consumer behavior.

5 Must Know Facts For Your Next Test

1. PED is calculated as the percentage change in quantity demanded divided by the percentage change in price.
2. Goods with close substitutes tend to have higher PED values, as consumers can easily switch to alternative products when the price changes.
3. Necessities, such as food and electricity, generally have lower PED values because consumers have a more inelastic demand for these goods.
4. PED can be used to predict the impact of price changes on total revenue, with elastic demand leading to an inverse relationship between price and total revenue.
5. Factors that affect PED include the availability of substitutes, the proportion of income spent on the good, and the time period considered.

Review Questions

• Explain how the concept of PED relates to the price elasticity of supply.
  • The price elasticity of demand (PED) and the price elasticity of supply (PES) are closely related concepts in economics. While PED measures the responsiveness of quantity demanded to changes in price, PES measures the responsiveness of quantity supplied to changes in price. The relationship between PED and PES is crucial in determining the impact of price changes on the equilibrium price and quantity in a market. For example, if a good has an elastic demand (high PED) and an inelastic supply (low PES), a change in price will have a greater impact on the quantity demanded than the quantity supplied, leading to a larger change in the equilibrium price.
• Describe how the availability of substitutes affects the PED for a good.
  • The availability of close substitutes is a key factor that influences the price elasticity of demand (PED) for a good. If a good has many close substitutes, consumers can easily switch to alternative products when the price of the original good increases. This makes the demand for the good more responsive to price changes, resulting in a higher PED value (elastic demand). Conversely, if a good has few or no close substitutes, consumers have a more inelastic demand for the good, leading to a lower PED value. The degree of substitutability is a critical determinant of how sensitive consumers are to price changes, and thus the PED for a particular good or service.
• Analyze how the time period considered affects the PED for a good, and explain the implications for businesses and policymakers.
  • The time period considered is a crucial factor in determining the price elasticity of demand (PED) for a good or service. In the short run, when consumers have limited ability to adjust their consumption patterns, the demand for a good is typically more inelastic (lower PED). However, as time passes, consumers have more opportunities to find substitutes, change their habits, or adjust their budgets, making the demand more elastic (higher PED). This has important implications for businesses and policymakers. In the short run, businesses may be able to raise prices without significantly reducing quantity demanded, allowing them to maintain or increase revenue. Policymakers, on the other hand, may find that taxes or subsidies have a more pronounced effect on quantity demanded in the long run, as consumers have more time to respond to the price changes. Understanding the time-dependent nature of PED is crucial for making informed decisions about pricing, taxation, and other economic policies.

Related terms

Demand Curve:

A graphical representation of the relationship between the price of a good or service and the quantity demanded of that good or service.

Elastic Demand:

A situation where the quantity demanded of a good or service is highly responsive to changes in its price, resulting in a PED value greater than 1.

Inelastic Demand:

A situation where the quantity demanded of a good or service is relatively unresponsive to changes in its price, resulting in a PED value less than 1.