Responsiveness changes the size of the outcome.
PED helps explain how quantity demanded responds to a policy-induced price change; PES explains sellers' ability to adjust quantity supplied. State what is held constant and the relevant time period. A tax may raise revenue while reducing consumption only slightly; a subsidy may lower buyer price without quickly expanding capacity. For controls, responsiveness affects the size of the shortage or excess supply.
- PED
- Price elasticity of demand (PED) measures the percentage quantity response to a percentage price change. Less responsive buyers cut purchases less after a policy raises their price.
- PES
- Price elasticity of supply (PES) measures sellers' percentage quantity response to a percentage price change. Extra staff or facilities may take time, limiting the immediate response.
- Objective
- Spending is price x quantity. A tax can reduce purchases slightly but raise spending because each remaining unit costs more. Judge the result against the policy's aim.
Apply both elasticities
Consumption target
When demand responds little to the resulting price rise, a tax may produce only a small quantity reduction. Availability of substitutes and time affect that response.
Subsidy and capacity
If supply is very price-inelastic, support may deliver little extra output quickly. Hiring staff or adding facilities may increase responsiveness later.
Controlled prices
For a given cut below the original price, a larger demand response raises Qd more; a larger supply response reduces Qs more. Together these widen the shortage, holding the initial equilibrium and price cut comparable. The reverse logic applies to a price floor and excess supply.
Revenue direction
When price falls along a fixed demand curve, elastic demand can raise buyer spending; inelastic demand can lower it. Calculate when endpoint data are provided.
Avoid a slope shortcut
A curve's visual steepness is not an elasticity value; axis scales and the price-quantity point matter.
Worked example: A levy aimed at reducing purchases
After a levy, meaning a tax, buyer price rises from $10 to $11. In market A, quantity falls from 100 to 98; in market B, it falls from 100 to 85. Other influences on demand are unchanged.
- Both markets face a 10% price rise. Using initial values, quantity falls 2% in A and 15% in B.
- PED = percentage change in quantity demanded / percentage change in buyer price. The quantity falls are negative: -2/10=-0.2 in A and -15/10=-1.5 in B. Their magnitudes, ignoring the sign, are 0.2 and 1.5, so A responds less.
- Buyer spending rises from $1,000 to $1,078 in A but falls to $935 in B. The stated objective of reducing purchases is better served in B.
- This compares responses to the same buyer-price change. It does not prove the same tax would produce that price change in both markets; supply also matters.
Watch out for this
A tax works only when consumer spending falls.
Success depends on the objective. Spending can rise even while consumption falls. Measure the intended outcome directly.
Check your understanding
A subsidy cuts fees, but providers have no spare places this term. Which constraint most directly limits the immediate quantity increase?
- Price-inelastic supply in the short run.
- Perfectly elastic supply.
- A change in the definition of demand.