Price elasticity of demand (PED) measures the responsiveness of quantity demanded to a change in the price of a good or service.
It shows how much quantity demanded changes in percentage terms when price changes by a given percentage.
→ A large change in quantity demanded after a small price change → elastic demand
→ A small change in quantity demanded after a large price change → inelastic demand
Why Use Percentages?
Different products have different units of measurement.
For example:
→ Cars may be measured in units.
→ Petrol may be measured in litres.
→ Electricity may be measured in kWh.
Using percentage changes makes comparisons easier.
Calculation of PED
The formula is:
PED = % change in quantity demanded ÷ % change in price
PED is normally expressed as a positive number when discussing its size, because price and quantity demanded move in opposite directions.
Example 1
The price of a product increases by 10% and quantity demanded falls by 20%.
→ % change in quantity demanded = 20%
→ % change in price = 10%
PED = 20 ÷ 10 = 2
Therefore:
→ PED = 2
→ Demand is elastic.
Example 2
Price increases by 20% and quantity demanded falls by 5%.
PED = 5 ÷ 20 = 0.25
→ PED = 0.25
→ Demand is inelastic.
Interpreting PED Values
| PED value | Type of demand | Meaning |
|---|---|---|
| 0 | Perfectly inelastic | Quantity demanded does not change when price changes |
| Between 0 and 1 | Inelastic | % change in quantity demanded is smaller than % change in price |
| 1 | Unitary elastic | % change in quantity demanded equals % change in price |
| Greater than 1 | Elastic | % change in quantity demanded is greater than % change in price |
| ∞ | Perfectly elastic | A tiny price change causes an extremely large change in quantity demanded |
Perfectly Inelastic Demand
PED = 0
→ Price can change
→ Quantity demanded remains unchanged.
Consumers demand the same quantity regardless of price.
Example
A life-saving medicine with no close substitute may have highly inelastic demand.
Demand Curve
→ A vertical demand curve represents perfectly inelastic demand.
Inelastic Demand
PED is between 0 and 1.
→ % change in quantity demanded < % change in price.
Example:
→ Price ↑ by 20%
→ Quantity demanded ↓ by 5%
→ PED = 0.25
Consumers are relatively unresponsive to price changes.
Demand Curve
→ A relatively steep demand curve represents inelastic demand.
Unitary Elastic Demand
PED = 1
→ % change in quantity demanded = % change in price.
Example:
→ Price ↑ by 10%
→ Quantity demanded ↓ by 10%
→ PED = 1
The percentage change in quantity demanded exactly matches the percentage change in price.
Elastic Demand
PED > 1
→ % change in quantity demanded > % change in price.
Example:
→ Price ↑ by 10%
→ Quantity demanded ↓ by 30%
→ PED = 3
Consumers are relatively responsive to price changes.
Demand Curve
→ A relatively shallow demand curve represents elastic demand.
Perfectly Elastic Demand
PED = ∞
→ Consumers are willing to buy at one particular price.
→ A very small increase in price causes quantity demanded to fall dramatically.
Demand Curve
→ A horizontal demand curve represents perfectly elastic demand.
Interpreting Demand Curves and PED
The slope of a demand curve and PED are related, but they are not exactly the same concept.
For Cambridge IGCSE Economics, remember:
→ Steep demand curve → relatively inelastic demand
→ Shallow demand curve → relatively elastic demand
→ Vertical curve → perfectly inelastic
→ Horizontal curve → perfectly elastic
The key idea is responsiveness.
Comparing Two Products
Suppose:
→ Demand for salt is relatively steep.
→ Demand for restaurant meals is relatively shallow.
This suggests:
→ Consumers are less responsive to changes in the price of salt.
→ Consumers are more responsive to changes in the price of restaurant meals.
Determinants of PED
The main factors determining whether demand is elastic or inelastic are:
Availability of Substitutes
This is one of the most important determinants.
→ Many close substitutes → demand more elastic
→ Few or no close substitutes → demand more inelastic
Example
If the price of one brand of bottled water increases:
→ Consumers can easily switch to another brand
→ Quantity demanded may fall significantly
→ Demand is relatively elastic.
For a product with no close substitute:
→ Consumers have fewer alternatives
→ Quantity demanded changes less
→ Demand is relatively inelastic.
Proportion of Income Spent on the Good
→ Large proportion of income → demand tends to be more elastic
→ Small proportion of income → demand tends to be more inelastic
Example
A large increase in the price of a car can significantly affect a household’s budget.
→ Car price ↑ → large financial impact → consumers may delay/reconsider purchase → demand relatively elastic.
A small increase in the price of a packet of salt may have little effect on household spending.
→ Price ↑ → very small effect on budget → quantity demanded changes little → demand relatively inelastic.
Necessity or Luxury
Necessities
→ Consumers need the product
→ More difficult to reduce consumption
→ Demand tends to be inelastic
Examples:
→ Basic medicines
→ Essential food
→ Basic electricity use
Luxuries
→ Consumers can often postpone or avoid buying them
→ Demand tends to be more elastic
Examples:
→ Luxury holidays
→ Expensive jewellery
→ High-end entertainment
Time Period
Generally:
→ Short period → demand tends to be more inelastic
→ Longer period → demand tends to become more elastic
Why?
Consumers need time to change their behaviour.
For example:
→ Petrol price ↑ today → drivers may still need to buy petrol.
→ Petrol price remains high for several years → consumers may buy fuel-efficient cars, use public transport or cycle.
→ Quantity demanded becomes more responsive.
Habit and Addiction
Products that are habit-forming or addictive tend to have inelastic demand.
→ Consumers may find it difficult to reduce consumption when price increases.
Examples:
→ Cigarettes
→ Some addictive substances
→ Products associated with strong habits
PED, Consumer Expenditure and Firms’ Revenue
PED is particularly important because it helps predict what happens to:
→ Consumer expenditure
→ Firm revenue
Formula
Total expenditure by consumers = Price × Quantity purchased
Total revenue of firms = Price × Quantity sold
In a simple market transaction:
Consumer expenditure = Firm revenue
When Demand Is Elastic
PED > 1
Quantity demanded changes by a larger percentage than price.
Price Increase
→ Price ↑
→ Quantity demanded falls proportionately more
→ Total expenditure/revenue falls
Price Decrease
→ Price ↓
→ Quantity demanded rises proportionately more
→ Total expenditure/revenue rises
Example
Price increases by 10%.
→ Quantity demanded falls by 30%
→ The fall in quantity is proportionately larger
→ Total revenue falls.
Therefore:
Elastic demand → price ↑ → revenue ↓
Elastic demand → price ↓ → revenue ↑
When Demand Is Inelastic
PED < 1
Quantity demanded changes by a smaller percentage than price.
Price Increase
→ Price ↑
→ Quantity demanded falls proportionately less
→ Total expenditure/revenue increases
Price Decrease
→ Price ↓
→ Quantity demanded rises proportionately less
→ Total expenditure/revenue decreases
Therefore:
Inelastic demand → price ↑ → revenue ↑
Inelastic demand → price ↓ → revenue ↓
When Demand Is Unitary Elastic
PED = 1
→ % change in price = % change in quantity demanded.
Therefore:
→ Price ↑ → quantity demanded falls by the same percentage
→ Price ↓ → quantity demanded rises by the same percentage
→ Total expenditure/revenue remains unchanged
PED and Revenue: The Key Relationship
| PED | Price increases | Price decreases |
|---|---|---|
| Elastic (>1) | Revenue ↓ | Revenue ↑ |
| Unitary (=1) | Revenue unchanged | Revenue unchanged |
| Inelastic (<1) | Revenue ↑ | Revenue ↓ |
Easy Rule
Elastic → price and revenue move in opposite directions.
Inelastic → price and revenue move in the same direction.
Unitary → revenue stays unchanged.
PED Shown Through Calculation
Example: Elastic Demand
A firm sells 1,000 units at ₹100.
Initial revenue:
→ ₹100 × 1,000
→ ₹100,000
The firm increases its price to ₹110 and quantity demanded falls to 600.
New revenue:
→ ₹110 × 600
→ ₹66,000
Therefore:
→ Revenue falls from ₹100,000 to ₹66,000.
The large fall in quantity demanded outweighs the increase in price.
→ Demand is elastic.
Example: Inelastic Demand
A firm sells 1,000 units at ₹100.
→ Initial revenue = ₹100,000
Price rises to ₹120 and quantity demanded falls to 950.
→ New revenue = ₹120 × 950
→ ₹114,000
Therefore:
→ Revenue increases from ₹100,000 to ₹114,000.
The percentage fall in quantity demanded is smaller than the percentage increase in price.
→ Demand is inelastic.
Using a Demand Diagram to Understand Revenue
On a demand diagram:
→ Price × quantity = expenditure/revenue
The rectangle formed by the price and quantity values represents the total expenditure by consumers and revenue received by firms.
When price changes:
→ The height of the rectangle changes because price changes.
→ The width changes because quantity demanded changes.
→ The overall area shows the effect on total expenditure/revenue.
For elastic demand:
→ Price increase causes a proportionately larger fall in quantity
→ Revenue rectangle becomes smaller.
For inelastic demand:
→ Price increase causes a proportionately smaller fall in quantity
→ Revenue rectangle becomes larger.
Significance of PED
PED is useful for decision-making by consumers, workers, producers/firms and governments.
Consumers
PED helps consumers understand how strongly their spending on a product may respond to price changes.
Inelastic products
→ Price ↑ → quantity demanded changes relatively little
→ Consumers may have difficulty reducing expenditure.
Example:
→ Essential medicine becomes more expensive
→ Consumers may still need to purchase similar quantities
→ Household expenditure increases.
Elastic products
→ Price ↑ → quantity demanded falls significantly
→ Consumers can switch to alternatives or postpone purchases.
Example:
→ Price of one restaurant increases significantly
→ Consumers may eat at another restaurant.
Workers
PED can help workers understand demand for the goods or services they produce, which can affect firms’ demand for labour.
For example:
→ Demand for a product ↑
→ Firms need to produce more
→ Demand for workers may ↑
→ Employment opportunities/wages may increase.
If demand for the product is highly responsive to price:
→ A price increase could cause a large fall in quantity demanded
→ Firms may reduce output
→ Demand for labour may fall.
Therefore, PED can influence employment opportunities in particular industries.
Producers and Firms
PED is especially important for pricing decisions.
If demand is elastic
A firm considering a price increase should be cautious:
→ Price ↑ → quantity demanded falls proportionately more → revenue ↓
The firm may instead consider:
→ Reducing price → quantity demanded ↑ significantly → revenue may ↑
If demand is inelastic
A firm may be able to increase price:
→ Price ↑ → quantity demanded falls proportionately less → revenue ↑
Therefore:
→ Firms need to understand PED before changing prices.
Other Business Decisions
PED can also help firms decide:
→ Pricing strategies
→ Sales promotions
→ Discounts
→ Advertising strategies
→ Whether entering a market is attractive
→ How consumers may respond to competitors’ prices
Governments
Governments can use PED when considering indirect taxes.
Taxing Products with Inelastic Demand
If demand is inelastic:
→ Tax ↑ → price ↑
→ Quantity demanded falls relatively little
→ Consumers continue buying the product
→ Government can raise significant tax revenue.
Examples may include:
→ Tobacco
→ Fuel
→ Alcohol
However, the government may also tax such products to reduce consumption, particularly where they create harmful effects.
Taxing Products with Elastic Demand
If demand is elastic:
→ Tax ↑ → price ↑
→ Quantity demanded falls significantly
→ Tax revenue may be lower than expected.
Therefore:
→ Governments need to consider PED when estimating the effects of taxation.
PED and Decision-Making: Summary
| Decision-maker | Why PED matters |
|---|---|
| Consumers | Helps understand how price changes may affect spending and purchasing decisions |
| Workers | Helps indicate how changes in demand for products may affect output, employment and demand for labour |
| Firms | Helps determine whether changing price is likely to increase or decrease revenue |
| Government | Helps predict the effects of indirect taxes on consumption and tax revenue |
The Complete PED Chain
Price changes → quantity demanded changes → PED determines the size of the response → consumer expenditure and firm revenue change
The most important relationships to remember are:
→ PED > 1 → Elastic → price ↑ → revenue ↓
→ PED < 1 → Inelastic → price ↑ → revenue ↑
→ PED = 1 → Unitary → price change → revenue unchanged
And for price decreases, the relationships reverse.