Preview
IB DP Economics — Unit 2: Microeconomics | SL | 2.5 Elasticities of Demand
📋 What You Will Learn
- Define price elasticity of demand (PED) and state the formula precisely
- Identify and distinguish the five degrees of PED with correct diagram shapes
- Explain the six key determinants of PED with real-world examples
- Analyse the relationship between PED and total revenue for firms and governments
- Apply PED to government taxation decisions and firm pricing strategy
- Evaluate the significance of PED in policy contexts using real-world evidence
🔍 Guiding Question How does the responsiveness of consumers to price changes determine the pricing power of firms and the revenue consequences of government taxation?
🌍 Why This Matters In 2023, the UK government raised tobacco duty by 15% — yet cigarette consumption fell by only around 6%, and tax revenue rose substantially. That same year, Ryanair reported that a modest fare increase on competitive European routes caused a sharp drop in bookings as passengers switched to rival carriers. The same mechanism — a price rise — produced opposite revenue outcomes. The difference is entirely explained by price elasticity of demand.
1. What Is Price Elasticity of Demand?
Every time a firm raises its price, quantity demanded falls — but by how much? A 10% price rise might cause a 2% fall in demand for petrol, or a 30% fall in demand for a luxury holiday. PED gives us a precise, comparable measure of this sensitivity. Without it, firms and governments would be guessing about the revenue consequences of price changes.
📖 Definition — Price Elasticity of Demand (PED) Price elasticity of demand measures the responsiveness of quantity demanded of a good to a change in its own price, ceteris paribus (all other factors held constant).
PED Formula
\[ \text{PED} = \frac{\% \Delta Q_d}{\% \Delta P} \] Where \( \% \Delta Q_d = \frac{Q_2 - Q_1}{Q_1} \times 100 \) and \( \% \Delta P = \frac{P_2 - P_1}{P_1} \times 100 \)
📌 Sign Convention
- PED is always negative — because price and quantity demanded move in opposite directions (the law of demand).
- For comparison purposes, PED is expressed as an absolute value |PED|.
- When the IB asks you to "calculate PED", show the negative sign in your working, then state the absolute value for interpretation.
2. The Five Degrees of PED
PED is not simply "elastic" or "inelastic" — it exists on a spectrum from zero to infinity. Understanding each degree matters because each implies a different demand curve shape and a different policy or pricing implication.
Perfectly Inelastic — PED = 0
- Quantity demanded does not change at all when price changes.
- Demand curve is vertical .
- Theoretical extreme — approximated by life-saving medicines with no substitutes (e.g. insulin for Type 1 diabetics).
- A price rise causes no fall in quantity demanded → total revenue rises proportionally with price.
Relatively Inelastic — 0 < |PED| < 1
- % change in Qd is smaller than % change in price.
- Demand curve is steep (but not vertical).
- Examples: petrol, cigarettes,