Skip to content

M05.L03 — Price Elasticity of Demand: Definition and Calculation

Module: Module 05 — Economic Surplus and Elasticity Lesson: L03 of 06 Duration: ~30 minutes Level: Introductory Provenance: Principles of Microeconomics (Curtis and Irvine) | Khan Academy Microeconomics

Learning Objective

Calculate and interpret price elasticity of demand (PED) using the midpoint method.

Price Elasticity of Demand (PED)

PED measures how quantity demanded responds to price changes: \( PED = \frac{\%\Delta Q_d}{\%\Delta P} \). Its absolute value determines elasticity: - Elastic (>1): Quantity changes more than price (e.g., luxury goods). - Inelastic (<1): Quantity changes less than price (e.g., necessities). - Unit elastic (=1): Proportional changes.

Australian examples include fuel (inelastic) and airline tickets (elastic).

Worked Example

Calculating PED for Cigarettes in Australia

  1. Initial Price (P1): $30/pack, Quantity (Q1): 1,000 packs.
  2. New Price (P2): $33/pack, Quantity (Q2): 900 packs.
  3. Midpoint Method:
  4. \( \%\Delta Q = \frac{900-1000}{(900+1000)/2} \times 100 = -10.53\% \)
  5. \( \%\Delta P = \frac{33-30}{(33+30)/2} \times 100 = 9.52\% \)
  6. \( PED = \frac{-10.53}{9.52} \approx -1.11 \) (elastic).

Common Misconception

"Elasticity is the same as slope."

Slope measures absolute changes, while elasticity measures percentage changes, which vary along a linear demand curve.

Key Takeaways

  • PED = %ΔQd / %ΔP (midpoint method avoids direction bias).
  • Elasticity depends on substitutes, necessity, income proportion, and time.
  • Australian tobacco taxes exploit inelastic demand.
  • Perfectly elastic/inelastic curves are theoretical extremes.

Practice

  1. If PED = -0.8 and price rises 5%, what happens to quantity demanded?
  2. Calculate PED when price falls from $10 to $8 and Qd rises from 50 to 70.
  3. Why is PED for petrol inelastic in Australia?

Further Resources

Provenance: Principles of Microeconomics (Curtis and Irvine) | Khan Academy Microeconomics