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💵principles of macroeconomics review

Price Elasticity of Demand (PED)

Written by the Fiveable Content Team • Last updated September 2025
Written by the Fiveable Content Team • Last updated September 2025

Definition

Price Elasticity of Demand (PED) is a measure of how responsive the quantity demanded of a good or service is to changes in its price. It quantifies the relationship between the percentage change in quantity demanded and the percentage change in price, providing insight into the sensitivity of consumer demand to price fluctuations.

5 Must Know Facts For Your Next Test

  1. The formula for calculating PED is: PED = (Percentage change in quantity demanded) / (Percentage change in price)
  2. PED is a dimensionless number, as it represents the ratio of two percentage changes.
  3. PED values can range from negative infinity to positive infinity, with a negative value indicating an inverse relationship between price and quantity demanded.
  4. Factors that influence PED include the availability of substitutes, the proportion of income spent on the good, and the time horizon considered.
  5. Understanding PED is crucial for businesses to set optimal prices, anticipate consumer reactions to price changes, and make informed decisions about production and marketing strategies.

Review Questions

  • Explain how the concept of PED is related to the price elasticity of supply.
    • The price elasticity of demand (PED) and the price elasticity of supply (PES) are closely related concepts that describe the responsiveness of market participants to price changes. While PED measures the sensitivity of quantity demanded to changes in price, PES measures the sensitivity of quantity supplied to changes in price. These two measures provide a comprehensive understanding of how a market will react to price fluctuations, as the interplay between demand and supply determines the equilibrium price and quantity in a market.
  • Analyze the implications of a good having an elastic or inelastic demand, and how this information can be used by businesses to make informed pricing decisions.
    • If a good has an elastic demand, it means that consumers are highly responsive to changes in price, and a small change in price can lead to a relatively large change in quantity demanded. In this case, businesses may be able to increase revenue by lowering prices, as the increase in quantity demanded would outweigh the decrease in price. Conversely, if a good has an inelastic demand, consumers are less responsive to price changes, and businesses may be able to increase revenue by raising prices, as the decrease in quantity demanded would be smaller than the increase in price. Understanding the PED of a product is crucial for businesses to set optimal prices, anticipate consumer reactions, and make informed decisions about production, marketing, and pricing strategies.
  • Discuss how the time horizon and the availability of substitutes can influence the price elasticity of demand for a good, and explain the implications of these factors for businesses.
    • The time horizon is a significant factor in determining the price elasticity of demand. In the short run, when consumers have limited options to adjust their consumption patterns, demand is typically more inelastic. However, in the long run, as consumers have more time to adapt and find substitutes, demand becomes more elastic. The availability of substitutes also plays a crucial role in PED. If a good has many close substitutes, demand for that good will be more elastic, as consumers can easily switch to alternative products in response to price changes. Conversely, if a good has few or no close substitutes, demand will be more inelastic, and consumers will have limited options to adjust their consumption. Businesses must consider these factors when setting prices, as they can significantly impact the effectiveness of their pricing strategies and the resulting changes in quantity demanded.

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