Overview
This lecture covers the law of demand, introduces price elasticity of demand (PED), explains its calculation and significance, and discusses factors affecting elasticity.
Law of Demand
- When price increases, quantity demanded decreases; when price decreases, quantity demanded increases.
- The law of demand describes this inverse price-quantity relationship.
Price Elasticity of Demand (PED)
- PED measures how quantity demanded responds to a change in price.
- The formula for PED is: percentage change in quantity demanded / percentage change in price ("Q before P").
- Percentage change = (new value - original value) / original value × 100.
- PED values are always negative due to the law of demand, but the sign can be ignored in interpretation.
Interpretation of PED Values
- PED > 1: Price elastic demand (quantity changes more than price).
- PED < 1: Price inelastic demand (quantity changes less than price).
- PED = 1: Unit price elastic demand (quantity changes exactly as price).
- PED = 0: Perfectly price inelastic (quantity doesn’t change when price changes).
- PED = ∞: Perfectly price elastic (quantity changes infinitely when price changes).
Calculation Examples
- Example 1: Cigarettes price rises from £4 to £5 (+25%), quantity demanded falls from 150 to 135 (−10%), PED = −0.4 (price inelastic).
- Example 2: Sofa price drops from £1,000 to £800 (−20%), quantity demanded rises from 2,000 to 3,800 (+90%), PED = −4.5 (price elastic).
Demand Curve Shapes
- Inelastic demand curve: steep slope.
- Elastic demand curve: shallow slope.
- Perfectly inelastic: vertical line; perfectly elastic: horizontal line.
Determinants of PED ("SPLAT")
- Substitutes: More substitutes = higher elasticity; fewer = more inelastic.
- Percentage of income: Higher % of income spent = more elastic.
- Luxury/Necessity: Luxuries = more elastic; necessities = more inelastic.
- Addictiveness/Habit forming: Addictive goods = more inelastic demand.
- Time period: Short run = inelastic; long run = more elastic.
Key Terms & Definitions
- Law of Demand — When price rises, quantity demanded falls, and vice versa.
- Price Elasticity of Demand (PED) — A measure of how much quantity demanded changes in response to price changes.
- Price Elastic — Demand changes proportionally more than price (PED > 1).
- Price Inelastic — Demand changes proportionally less than price (PED < 1).
- Unit Price Elastic — Demand changes exactly in proportion to price (PED = 1).
- Perfectly Price Inelastic — Demand does not change with price (PED = 0).
- Perfectly Price Elastic — Any price change leads to infinite change in quantity demanded (PED = ∞).
Action Items / Next Steps
- Practice more PED calculations.
- Learn to draw demand curves for different elasticity scenarios.
- Prepare for the next lecture on the link between PED and total revenue.