CAMBRIDGE AS & A LEVEL : 18.10 PED

Introduction

This tutorial will guide you through the concept of Price Elasticity of Demand (PED), a crucial topic in economics, particularly for Cambridge AS & A Level students. Understanding PED helps in analyzing how the quantity demanded of a good changes in response to price changes, which is vital for making informed business decisions.

Step 1: Understand the Definition of PED

• Price Elasticity of Demand measures how sensitive the quantity demanded of a good is to a change in its price.

• It is calculated using the formula:

  [ \text{PED} = \frac{\text{Percentage Change in Quantity Demanded}}{\text{Percentage Change in Price}} ]

• If PED is greater than 1, demand is elastic; if less than 1, demand is inelastic; if equal to 1, demand is unitary elastic.

Step 2: Identify Types of PED

• Elastic Demand: A small change in price leads to a large change in quantity demanded (PED > 1).
• Inelastic Demand: A change in price has little effect on the quantity demanded (PED < 1).
• Unitary Elastic Demand: A change in price leads to an equal change in quantity demanded (PED = 1).

Step 3: Recognize Factors Affecting PED

• Availability of Substitutes: More substitutes generally lead to more elastic demand.
• Necessity vs Luxury: Necessities tend to have inelastic demand, while luxuries are often elastic.
• Proportion of Income: Goods that take up a large proportion of income tend to have more elastic demand.
• Time Period: Demand elasticity can vary over time; it tends to be more elastic in the long run.

Step 4: Calculate PED with Examples

• To calculate PED, follow these steps:

  1. Determine the initial quantity demanded and the new quantity demanded after a price change.
  2. Calculate the percentage change in quantity demanded.
  3. Determine the initial price and the new price.
  4. Calculate the percentage change in price.
  5. Use the PED formula to find the elasticity.

• Example: If the price of a product rises from $10 to $12 (20% increase), and the quantity demanded falls from 100 to 80 units (20% decrease):

  [ \text{PED} = \frac{-20%}{20%} = -1 ]

  This indicates unitary elasticity.

Step 5: Apply PED in Real-World Scenarios

• Pricing Strategies: Businesses can use PED to set prices. For elastic products, a price decrease can lead to higher total revenue.
• Taxation Policies: Governments consider PED when imposing taxes on goods. Inelastic goods may yield higher tax revenue.
• Market Research: Understanding PED helps businesses forecast demand changes due to price adjustments.

Conclusion

Understanding Price Elasticity of Demand is essential for effective decision-making in business and economics. By mastering its definition, types, influencing factors, calculation methods, and real-world applications, you can apply this knowledge to various scenarios. As a next step, practice calculating PED with different products to solidify your understanding and explore how businesses use this concept in their pricing strategies.