Every business that has ever cut a price has been asking the same question: will enough extra customers arrive to make up for the money lost on each sale? Price elasticity of demand is the tool economists use to answer it. It measures how strongly buyers react when a price changes.
Price elasticity of demand
A measure of the responsiveness of quantity demanded to a change in price.
PED = % change in quantity demanded ÷ % change in priceFormulae are not supplied in the exam. You must recall this.
Calculating PED
A café raises the price of a coffee from 10 to 12 riyals. Weekly sales fall from 500 cups to 400. Calculate PED.
Ignore the minus sign when judging the strength of the response, and read only the size of the number. A coefficient between 0 and 1 means demand is inelastic: buyers barely react, so quantity changes proportionately less than price. A coefficient greater than 1 means demand is elastic: buyers react sharply, and quantity changes proportionately more than price.
The negative sign is not an error. Demand curves slope downward, so price and quantity always move in opposite directions and PED is almost always negative. Show the sign in your working, then discuss the magnitude. Candidates who claim the negative sign means demand is inelastic lose the interpretation mark every time.
A 10% fall in the price of a good causes quantity demanded to rise by 25%. What is the PED?
Whether demand is elastic or inelastic depends mainly on how easily buyers can escape the price rise. Close substitutes make demand elastic, because customers simply switch. Necessities tend to be inelastic, since people buy them regardless. Goods taking a large share of income are more elastic, because the price change is felt more keenly. Habit-forming goods are inelastic. Time matters too: demand becomes more elastic in the long run as buyers find alternatives.
Sketch two demand curves through the same point, one elastic and one inelastic, and show how the same price rise affects quantity differently on each.
A steeper curve indicates more inelastic demand over that range. Label both axes and mark the quantity change on each.