1) Explain the term 'price elasticity of demand' and 'income elasticity of demand' and

show how they are measured.

Demand refers to the quantity of a good or service that a consumer is willing to buy
at a given price. Elasticity can be defined by a measure of how an economic
variable respond to a changes in another economic variable.

Price Elasticity of Demand

Price elasticity of demand (PED) is a measure used in economics to show the responsiveness of the
quantity demanded of a good or service to a change in its price, ceteris paribus. It specifies the sensitivity
of the quantity demanded of a good to a change in its price. While the law of demand depicts the direction
of the relationship between demand and price, PED illustrates the magnitude of the relationship. If the
price elasticity of demand is equal to 0, demand is perfectly inelastic, that is, demand does not change
when price changes. Values between zero and one indicate that demand is inelastic. This occurs when the
percent change in demand is less than the percent change in price. When price elasticity of demand equals
one, demand is unit elastic, that is, the percent change in demand is equal to the percent change in price.
Finally, if the value is greater than one, demand is perfectly elastic leading to demand being affected to a
greater degree by changes in price.

Price elasticity of demand can be measured by dividing the percentile change in the quantity
demanded of a product by the percentile change in the products price as shown below: -

PED = Percentage change in quantity demanded (% QD)

Percentage change in price (% P)

PED= - Q/ Q
P/ P

=-Q*P
Q P

=-Q*P
P

As the law of demand states that there is a negative relationship between price and quantity
demanded of a product, the coefficient of PED is normally negative.

Figure 1
From the Figure 1 above, the following can be depicted
1. If Ped = 0, demand is perfectly inelastic - demand does not change at all when the price changes
the demand curve will be vertical.
2. If Ped is between 0 and 1 (i.e. the % change in demand is smaller than the percentage change in
price), then demand is inelastic.
3. If Ped = 1 (i.e. the % change in demand is exactly the same as the % change in price), then
demand is unit elastic. A 15% rise in price would lead to a 15% contraction in demand leaving
total spending the same at each price level.
4. If Ped > 1, then demand responds more than proportionately to a change in price i.e. demand is
elastic. For example, if a 10% increase in the price of a good leads to a 30% drop in demand. The
price elasticity of demand for this price change is 3

Perfectly Inelastic Demand (PED=0)

A perfectly Inelastic Demand Curve implies that consumers are willing and able to pay any price

for the product. If supply falls, equilibrium market price can rise without any contraction in the
quantity demanded.

Elastic Demand (PED>1)

If demand for a product is price elastic, a supplier stands to gain extra revenue if he reduces its
price. The change in quantity demanded will be proportionately higher than the reduction in price

Unit Elastic Demand (PED=1)

With a Demand curve of unitary price elasticity, a change in price is met with a proportionate
change in demand. This means that total spending by consumers on the product will remain the
same at each price level

Inelastic Demand (PED<1)

Following a change in price, total revenue earned by a firm will depend on PED for its product. If
the coefficient of PED is <1, a rise in market price will lead to an increase in total revenue