Price Elasticity of Demand (PED) is defined as the responsiveness of quantity demanded to a change in price. The demand for a product can be elastic or inelastic, depending on the rate of change in the demand with respect to the change in the price.

## Formula

%∆ in Qd = Percentage Change in Quantity Demanded. The Percentage Change in Quantity Demanded is the New Quantity Demanded minus the Old Quantity Demanded divided by the Old Quantity Demanded.

%∆ in P = Percentage Change in Price. This is the New Price minus the Old Price divided by the Old Price.

## Determinants of Price Elasticity of Demand (PED)

These factors include:

### 1. Substitutes

The greater the number and availability of close substitutes, the higher the value of its elasticity. For example, if the price of one footwear brand goes up, people can turn to other brands. So, a small change in price is likely to cause a greater fall in quantity demanded.

### 2. Necessities

The degree of necessity of a good or service will affect its PED. Products that are essential tends to be relatively price inelastic For example, if the price for drinking water rises, then there is unlikely to be a huge drop in the quantity demanded since drinking water is a necessity; but Luxury products (Fendi designer bags, Christian Louboutin Shoes and Balenciaga Shirts) is largely price elastic as they are not necessities for most households.

### 3. Time

The period under consideration can affect the value of PED. Over time, a good tends to become more elastic because consumers and businesses have more time to find alternatives or substitutes. For example, if the price of gasoline goes up, over time people will adjust for the change, i.e., they may drive less or use public transportation or form carpools.

### 4. Habit

The demand for addictive or habitual products is usually inelastic. This is because the consumer has no choice but no pay whatever the producer is demanding. For example, if the price for a pack of cigarettes goes up, it will likely not have any effect on demand.

### 5. Income

The proportion of a consumer’s income that is spent on a product also affects the value of its PED. If the price of toothpaste were to double, the percentage change in price would be so insignificant to the consumer’s overall income that quantity demanded would be hardly affected as against an increase in transport fare which increased which has a larger impact on their disposable income.

## Types of Price Elasticity

### 1. Perfectly Inelastic Demand, (PED = 0)

With a perfectly inelastic demand, there is no change in the demand for a product with a change in its price. This means that the demand remains constant for any value of price. The demand curve is represented as a straight vertical line.

It is practically impossible to find a product that has perfectly inelastic demand. The closest thing could be essentials like water or certain food products.

This is the effect on total revenue with a change in price:

• Price ↑ → Total Revenue ↑
• Price ↓ → Total Revenue ↓

### 2. Relatively Inelastic Demand, (PED = 0 < x < 1)

Relatively inelastic demand occurs when the percentage change in demand is less than the percentage change in the price of a product.

For example, if the price of a product increases by 15% and the demand for the product decreases only by 7%, then the demand would be called relatively inelastic.

The demand curve of relatively inelastic demand is rapidly sloping.

This is the effect on total revenue with a change in price:

• Price ↑ → Total Revenue ↑
• Price ↓ → Total Revenue ↓

### 3. Unitary Elastic Demand, (PED = 1)

Demand is said to be unit elastic when the proportionate change in demand produces the same change in the price. The quantity demanded changes by the same percentage as the change in price.

This is the effect on total revenue with a change in price:

• Price ↑ → No Change in Total Revenue
• Price ↓ → No Change in Total Revenue

### 4. Relatively Elastic Demand, (PED = 1 < x < ∞)

Relatively elastic demand is defined as the proportionate change produced in demand is greater than the proportionate change in the price of a product. The quantity demanded changes by a larger percentage than the change in price.

For example, if the price of a product increases by 10% and then the demand for the product decreases by 15%, then the demand would be relatively elastic.

The demand curve of relatively elastic demand is gradually sloping. It is less steep than relatively inelastic demand.

This is the effect on total revenue with a change in price:

• Price ↑ → Total Revenue ↓
• Price ↓ → Total Revenue ↑

### 5. Perfectly Elastic Demand, (PED = ∞)

In Perfectly Elastic Demand, a small rise in price will result in a fall in demand to zero, while a small fall in price will result in the demand to become infinite. Consumers will buy all available at some price, but none at any other price. This is a theoretical concept because it requires perfect competition where the slightest price increase results in zero demand.

In a perfectly elastic demand, the demand curve is represented as a horizontal straight line.

This is the effect on total revenue with a change in price:

• Price ↑ → 0 Total Revenue
• Price ↓ → 0 Total Revenue

## Significance of PED for decision makers

• Helping Producers to decide on their pricing strategy: A firm whose product is inelastic is likely to increase prices knowing that quantity demanded would be highly affected. This would increase their revenue since they would be selling at a higher price.
• Goods to impose taxes on: taxing price inelastic products ensures the government can collect large sums of tax revenue without seriously affecting the overall demand for the product, this can also help producers determine how much of a tax can be passed to the consumers
• Determining taxation policies: Knowledge of PED can help governments to determine taxation policies, the government can impose heavy taxes on demerit goods which has its demand as price inelastic. As demerit goods are harmful to the society, the heavy taxes would reduce its consumption.
• Price discrimination: this occurs when firms charge different customers different prices for essentially the same product because of their differences in their PED.