Price Elasticity of Demand (PED)
Definition
Per (Gans et al.), price elasticity of demand (PED) is a measure of how responsive quantity demanded (Q) of a good is to a change in the price (P) of the good.
Consumers can be elastic (responsive to changes in P), inelastic (not very responsive to changes in P), or unit elastic (change in demand is exactly proportional to change in P).
Why It Matters
One reason elasticity is important to understand is that it helps to predict consumer’s behaviour. This helps businesses with their pricing strategies.
Example
For example, if the PED of a product is 2, then for every 1% change in price will lead to a 2% change in quantity demanded.
Limitation
One limitation of elasticity, per “Price Elasticity - the Decision Lab” (2025), is it assumes consumers are rational, which is the biggest criticism of economics. Reality isn’t black and white, instead it’s shaped by cognitive biases, emotions, and context. For example, our willingness to pay shifts with expectations and how we frame value in the moment, like how it feels to pay $7 for a coffee in the morning and then paying $7 for a cocktail at night. Human’s decisions aren’t linear.
Determinants of PED
What determines whether the price elasticity of demand is high or low? (Per Gans et al.)
- Availability of close substitutes
More substitutes (alternatives) means higher price elasticity.
- Necessities versus Luxuries
Elasticity is higher for luxuries
Elasticity is lower for necessities
- Time horizon
Elasticity tends to be higher in the long run.
Application: do drug bans increase or decrease drug related crime?
The government can implement two alternative policies;
1. Increase law enforcement, arrest drug smugglers and stop some drugs from entering the country
2. Increase drug education and treatment programs
What Effect Will These Two Policies Have on Total Expenditure on Drugs?
Per (Gans et al.)
1. Demand for drugs is considered inelastic, therefore if law enforcement reduces the supply, price will rise, and demand will decrease only slightly. Thus, TR increases, suggesting that this policy may increase drug related crime.
2. These programs could reduce demand for drugs, so demand will decrease, so will price, and therefore TR falls, suggesting that this policy may reduce drug related crime.
Work cited:
Gans, Joshua, et al. Principles of Microeconomics. South Melbourne, Victoria, Australia, Cengage Learning Australia, 2021.
“Price Elasticity - the Decision Lab.” The Decision Lab, 2025, thedecisionlab.com/reference-guide/economics/price-elasticity.
