Unit 2.5: Price elasticity of demand
Until now your students will have largely worked on the assumption that demand is linear and that the relationship between selling price and quantity demanded was the same or at least similar for most products - the exceptions being giffen and veblen goods. This section of the site focuses on how the relationship between the two variables changes, according to the elasticity of the good or service. This page concentrates on the first of the 4 types of elasticity in economics.
Price elasticity of demand can be described as the responsiveness of quantity demand to changes in the selling price of a good or service.
Enquiry questionAn understanding that the change in quantity demanded for different goods and services will respond differently to changes in price.
Lesson time: 1 hour
An understanding of the concept of price elasticity of demand, as the responsiveness of quantity demanded to a change in price, along a given demand curve
Learning how to calculate PED using the equation percentage change in quantity demanded / percentage change in price
An understanding that the PED value is treated as if it were positive, although its mathematical value is usually negative.
Explain, using diagrams and PED values, the concepts of price elastic demand, price inelastic demand, unit demand, perfectly elastic demand and perfectly inelastic demand.
1. Start by drawing three PED diagrams on the whiteboard, one PED inelastic, one elastic and the other PED unitary. have your classes draw the same in their books and then label each with three different products e.g. cruise holidays, bread and second hand cars. Ask your students to think about which good is likely to see the largest change in quantity demanded following a change in price?
2. Next, have your classes write down a list of your 5-10 main expenditures and write down whether the good is a basic necessity for you or a luxury item? Suppose each of the items on your list rose in price by 10%. Now next to each assign one of the following labels to each item:
a. Following a rise in price of 10%, I would reduce my consumption of the product by more than 10%.
b. Following a rise in price of 10%, I would reduce my consumption of the product by less than 10%.
c. Following a rise in price of 10%, I would reduce my consumption of the product by about 10%.
3. Video on price elasticity
Watch the following short video before reading the handout that your teacher will give you.
Price elasticity of demand (PED): The responsiveness of quantity demanded to changes in the selling price of a good or service.
PED formulae: % change in quantity demanded / % change in selling price.
PED elastic good: A good or service where a change in the price of the product leads to a greater than proportional change in quantity demanded. PED elastic goods have a PED greater than 1 (a top heavy fraction).
PED inelastic good: A good or service where a change in the price of the product leads to a smaller than proportional change in quantity demanded. PED inelastic goods have a PED less than 1 (a bottom heavy fraction).
PED unitary good: A good or service where a change in the price of the product leads to a proportional change in quantity demanded. Unitary elastic goods have a PED = 1.
Examples of PED elasticity
1. A good sees a 10% rise in quantity demanded in response to a 5% fall in price. This would be expressed by the equation 10 / 5 = 2 (elastic PED)
2. Quantity demanded for a service rises by just 2% in response to a fall in the price of the service of 20%. This would be expressed by the equation 2 / 20 = 0.1 (PED inelastic)
3. When the price for a good rises from £ 5 to £ 6, quantity demanded for that product falls by 20%. This would be expressed as 20 / 20 = 1 (unitary elasticity).
1. The following three diagrams represent the market for three different products - cruise holidays, bread and second hand cars.
Which diagram represents each good?
The next two diagrams illustrate a perfectly elastic demand curve, with a PED of infinity, as well as a good with a PED of 0. Which is which?
Activity 3: Calculating PED elasticity
1. Calculate the PED for each product, and then comment on your result.
(a) The price of a camera is valued at $150, and the quantity demanded at this price is 4 million units. During the end of year sales the shop reduces the price to $130 and as a result the quantity demanded rises to 6m.
(b) The same shop sells batteries for their cameras for just $1, and the quantity demanded is 10 million. Following a price rise to $1.10 the quantity demanded falls to 9,500,000 units.
(c) The same shop also sells flash lights for $5, and the quantity demanded at this price is 2 million units. Following a reduction in the selling price to $4.50, quantity demanded rises to 2.2m
Orhan Bufe is a snack and sandwich shop, operating in the popular Blue Mosque area of the city, where there are many similar businesses operating. Its fastest selling products are hamburgers, cheese toasties and shish kebabs. These products currently sell for the following prices: hamburgers 10 TL, cheese toasties 8TL and the shish kebab, the Bufe’s signature dish sells for 12 TL. In 2018 the firm sold 10,000 hamburgers, 15,000 cheese toasties and 40,000 shish kebabs.
In an attempt to try and improve revenue the owner Orhan Uluturk decided to increase all prices by 10%. Market research gained from other similar shops in the area suggests that the price elasticity of demand for each product is:
Hamburger: (-) 1.5; Cheese toast : (-) 2.0; shish kebab: (-) 0.6
You have been asked to evaluate the planned price increases.
(a) Comment on the planned price changes.
(b) Would a 10% price reduction have been better for some or all of the products?
(c) What benefit (if any) would advertising bring to the firm?
A local delivery firm produces three types of home cooked food for delivery to homes in the local area. The firm completed market research, to discover the likely demand curves for each of the three meal packages. The results are shown below: (Monthly sales).
Packet A (Qd)
Packet B (Qd)
Packet C (Qd)
(a) Calculate PED for all three packages over the price range £10 to £11.
(b) What price must be charged for each package if the firm wishes to maximise their sales revenue?
Class notes available as a PDF at: Elasticity
An important note about elasticity
Sometimes during your IB classes one of your students may describe a PED elastic good as a good or service which changes when price changes. Similarly they may describe a PED inelastic good as one that doesn't change when price changes. This is of course false, demand for the vast majority of products changes in response to a change in price, both PED elastic and inelastic goods − perfectly inelastic goods are the exception. The difference is the degree to which demand for the good or service changes.
4. Link to the assessment
The concept of PED elasticity can appear across all sections of the assessment. In paper one candidates may be asked to explain the concept of PED in relation to two different products, for example the luxury and used car markets, while in paper two PED elasticity is used to explain the relationship between the price of a nation's currency (exchange rate) and its current account (trading) balance. In paper three students may be asked to calculate the PED of a given good or service, from a given set of numerical data and / or required to explain which factors determine the price elasticity of demand for a product.
The concept of PED elasticity can also be used as part of the internal assessment e.g. an article relating to the relative PED inelasticity of cigarettes or oil and may also form part of an extended essay in economics.
5. Reflection: Elastic band activity
This fun interactive activity is a good way of learning the concept of elasticity, by connecting the responsiveness of rubber bands to the responsiveness of quantity demand to a price change. Start by handing out a handful of different rubber bands, some that stretch more than the others. Using a pen or felt tip marker students will then be instructed to write the different name of a good or service on the elastic band, according to how PED elastic or inelastic the product is.
As the students are stretching the rubber bands, you will need to highlight that the rubber band that stretches more has a larger response to being pulled and is considered elastic. The rubber band that stretches less, i.e. is less responsive can be considered inelastic.
This activity should take no more than 10 minutes or so and afterwards some of your students can demonstrate what they have learned, by stating the name(s) of the product as they stretch the elastic by the appropriate amount.