Define and calculate price elasticity of demand, interpret its value, and explain its determinants

What this dot point is asking

SEAB wants you to define and calculate the price elasticity of demand (PED), interpret what its value means, and explain what determines whether demand is elastic or inelastic. Because numerical PED questions appear regularly, the formula must be automatic, and because PED drives so much of the rest of the course, the determinants must be at your fingertips.

The answer

Defining and calculating PED

Always compute the two percentage changes first, then divide. PED is negative because price and quantity move in opposite directions (the law of demand); we usually describe its size by the magnitude (its absolute value).

Interpreting the value

Using the magnitude $|PED|$:

• $|PED| > 1$: demand is elastic. Quantity changes proportionately more than price.
• $|PED| < 1$: demand is inelastic. Quantity changes proportionately less than price.
• $|PED| = 1$: unit elastic. Quantity changes in the same proportion as price.
• $|PED| = 0$: perfectly inelastic (a vertical demand curve); quantity does not respond at all.
• $|PED| = \infty$: perfectly elastic (a horizontal demand curve); any price rise sends quantity to zero.

Determinants of PED

What makes demand responsive:

• Availability and closeness of substitutes. The more, and the closer, the substitutes, the more elastic demand, because consumers can switch easily. This is usually the most important determinant.
• Proportion of income spent on the good. The larger the share of income, the more elastic, because price changes matter more.
• Necessity versus luxury. Necessities are inelastic; luxuries are more elastic.
• Habit-forming or addictive goods. These are inelastic (cigarettes, caffeine).
• Time period. Demand is more elastic in the long run, as consumers find substitutes and change habits.
• Definition of the market. A narrowly defined good (one brand) is more elastic than a broadly defined one (the whole category).

Examples in context

Example 1. Tobacco taxation in Singapore. Demand for cigarettes is inelastic (around $-0.4$ to $-0.5$) because they are addictive with few close substitutes. This is why high tobacco duties raise substantial revenue while reducing consumption only modestly, and why the policy combines tax with advertising bans and cessation support to shift demand as well.

Example 2. Brand versus category. Demand for one airline's tickets on a competitive route is highly elastic, because travellers can easily switch carriers, while demand for air travel as a whole is far less elastic. The same product can be elastic or inelastic depending on how narrowly the market is defined.

Try this

Q1. Price rises 20 percent and quantity demanded falls 30 percent. Calculate PED and classify it. [2 marks]

• Cue. $PED = \dfrac{-30\%}{+20\%} = -1.5$; the magnitude exceeds 1, so demand is elastic.

Q2. Explain why demand for a particular brand is more elastic than demand for the product category. [3 marks]

• Cue. A single brand has many close substitutes (rival brands), so consumers switch easily, making it elastic; the whole category has fewer substitutes, so its demand is less elastic.

Q3. Explain why demand becomes more elastic over time. [2 marks]

• Cue. Given time, consumers find and adopt substitutes and adjust habits and equipment, so quantity responds more fully to a price change in the long run.