Price Elasticity of Demand
— Economics · AS Level · PED —
★ Starred on the board: the PED formula PED = % Δ QD ÷ % Δ Price and TR = Price × Quantity. Know both by heart — everything else (types, factors, what a producer does) hangs on them. All 5 types of PED are ticked ✓ on the board as must-know.
1. What is Price Elasticity of Demand?
Idea: PED measures responsiveness — how much the quantity demanded (QD) changes when the price changes.
Price change → QD change (price and QD have a negative relationship = Law of Demand)
Remember: PED = dependent ÷ independent. QD is the dependent variable (it responds), price is the independent one (it is changed).
★ PED formulaPED = % Δ in QD% Δ in Price
% change (used for both QD and price)% change = New − OldOld × 100
2. Calculating PED — ignore the negative sign
Board examplePED = % Δ QD% Δ Price= 100%−50%= −2ignore the − sign ⇒ 2 ⇒ PED > 1 ⇒ ELASTIC demandelastic ⇒ Price ↓ , QD ↑ , TR ↑ (e.g. 10% , 50%)
Common mistake: do not keep the negative sign. Always ignore it while calculating PED.
Why ignore the negative sign?
- The − sign only shows the negative relationship between price and QD (law of demand) — we already know that.
- Ignore it → you can identify the elasticity of demand (PED > 1, < 1, = 1).
- Then the producer can plan the pricing strategy accordingly → to maximise revenue.
Flow: ignore − sign ⟶ identify elasticity ⟶ set pricing strategy ⟶ TR maximised
Quick checks (board margin): answer 0.8 ⇒ PED < 1 ⇒ inelastic (IED). Values −1, 0, ∞ are also listed: −1 → ignore sign → 1 (unitary); 0 = perfectly inelastic; ∞ = perfectly elastic.
3. Types of Elasticity
| # | Type | PED | Group |
|---|---|---|---|
| 1 | Elastic demand | PED > 1 | |
| 2 | Inelastic demand | PED < 1 | |
| 3 | Unitary elastic demand | PED = 1 | Extreme cases ⎫ |
| 4 | Perfectly elastic demand | PED = ∞ | |
| 5 | Perfectly inelastic demand | PED = 0 |
① Elastic demand (PED > 1)
- Greater than one → high responsiveness; QD changes by a larger %.
- Substitutes ↑, alternatives ↑, options ↑ → more chances to switch.
- Luxury product (want) → flatter curve.
- e.g. cars, mobile phones.
- Price ↓ → QD ↑ → TR ↑ (10% price fall, 50% QD rise). Price → smaller change.
Write it like this:
Elastic demand is greater than 1, it has high responsiveness as there are more substitutes available so consumers have more chances to switch if prices change, and the product is a luxury. A smaller % change in price (10%) will increase quantity demanded by a larger % (50%).② Inelastic demand (PED < 1)
- Less than one → low responsiveness; QD changes by a smaller %.
- Substitutes ↓, alternatives ↓, options ↓ → less chances to switch.
- Necessity product (need), Unique Selling Point, brand loyal customers → steep curve.
- e.g. petrol, Apple, basic necessities.
- Price ↑ → QD ↓ → TR ↑ (50% price rise, 10% QD fall). Price → larger change.
Write it like this:
Inelastic demand is less than 1, it has low responsiveness so there are fewer substitutes, fewer chances to switch, the product is a necessity and consumers are brand loyal with a Unique Selling Point. A larger % change in price (50%) will contract quantity demanded by a smaller % (10%).| Elastic (ED) | Inelastic (IED) | |
|---|---|---|
| PED | > 1 | < 1 |
| Responsiveness | high | low |
| Change in QD | larger % | smaller % |
| Substitutes / options | ↑ (more chances to switch) | ↓ (less chances to switch) |
| Product | luxury (want) | necessity (need), USP, brand loyal |
| Curve | flatter | steep |
| Examples | cars, mobile phones | petrol, Apple, basic necessity |
| Price → QD → TR | P ↓ (10%) QD ↑ (50%) TR ↑ | P ↑ (50%) QD ↓ (10%) TR ↑ |
③ Perfectly elastic demand (PED = ∞)
- 1000s of substitutes and 1000s of producers; homogeneous / identical product — same product, same price.
- Firms are price takers (market share too small to influence price). Objective: survival.
- Perfect knowledge, no price discrimination; horizontal curve. e.g. Kirana shops, petrol pumps.
- Price ↑ → producer is out of the market.
- Price ↓ → loss for everyone (others follow the same pricing strategy).
- Price – (unchanged), QD ↑, TR ↑ (10% , 10%).
Write it like this:
In perfectly elastic demand PED is infinite; the only way to increase revenue is by selling more units, i.e. % change in QD = % change in total revenue.④ Perfectly inelastic demand (PED = 0)
- No responsiveness → no change in QD; no substitute available.
- Single firm = monopoly → price maker (decides the price level).
- Imperfect knowledge, price discrimination possible; vertical curve.
- e.g. K-Electric, life-saving drugs.
- Price ↑ , QD – (unchanged), TR ↑ by the same % (50% , 50%).
⑤ Unitary elastic demand (PED = 1)
- Equal responsiveness: % change in price = % change in QD.
- Price ↓ , QD ↑ , TR – (unchanged) (10% , 10%).
- Curve = rectangular hyperbola.
Note: TR can never be increased under unitary elastic demand, because of the equal responsiveness — TR stays unchanged.
| Perfectly elastic | Perfectly inelastic | Unitary | |
|---|---|---|---|
| PED | ∞ | 0 | 1 |
| Responsiveness | infinite | none | equal |
| Substitutes | 1000s | none | — |
| Producers | 1000s (identical product) | single firm (monopoly) | — |
| Price role | price taker | price maker | — |
| Knowledge / discrimination | perfect / none | imperfect / yes | — |
| Curve | horizontal | vertical | rect. hyperbola |
| Examples | kirana, petrol pumps | K-Electric, life-saving drugs | — |
| P → QD → TR | P – , QD ↑ , TR ↑ (10%,10%) | P ↑ , QD – , TR ↑ (50%,50%) | P ↓ , QD ↑ , TR – (10%,10%) |
Note (board graph): on the perfectly inelastic graph the P → P₁ rise is marked 10%, while the text rows use 50%. The size is only an illustration — what matters: QD unchanged, so TR rises by the same % as price.
4. Factors Affecting PED
Each factor pushes demand towards elastic (ED) or inelastic (IED).
| Factor | → Inelastic (IED) | → Elastic (ED) |
|---|---|---|
| 1) Availability of substitutes | substitutes ↓ | substitutes ↑ |
| 2) Type of product | necessity product | luxury product |
| 3) Time period | short run | long run |
| 4) Addiction | addictive | non-addictive |
| 5) % of income spent on the good | low % (necessity) | high % (luxury) |
Exam wording for each factor
- Necessity or luxury: a necessity ⇒ inelastic ⇒ a change in price has less effect on QD. A luxury ⇒ elastic ⇒ a change in price has greater effect on QD.
- Addiction: addictive good ⇒ inelastic ⇒ lesser effect on QD. Not an addiction ⇒ elastic ⇒ greater effect on QD.
- Availability of substitutes: more substitutes ⇒ elastic ⇒ greater effect. Fewer substitutes ⇒ inelastic ⇒ lesser effect.
- % proportion of income: a large proportion of income ⇒ elastic ⇒ greater effect. A smaller proportion ⇒ inelastic ⇒ lesser effect.
Time period is the 5th factor — see below.
Time period
Write it like this:
Time period can be categorised under two headings: short run and long run. In the short run the product has inelastic demand due to its Unique Selling Point, but as time passes (the long run) the USP becomes available with everyone, there are more substitutes, and the product with inelastic demand turns into elastic demand.5. Total Revenue (TR)
- TR = total sales = total income of the producer.
- Consumer expenditure = Producer revenue or Total expenditure = Total revenue (the consumers’ spending is the producer’s income).
★ FormulaTR = Selling price × No. of units
or
TR = Price × Quantity
or
TR = Price × Quantity
From the graph (P = 10, Q = 20)TR = Price × QtyTR = OP × aQTR = area OPaQTR = 10 × 20 = $200
6. Usefulness of PED to a Producer
Information: PED tells the producer how consumers respond to price. Aim: TR maximise.
Identify elasticity ⟶ set pricing strategy ⟶ TR maximise
- Elastic (substitutes ↑, luxury): the producer reduces price by a smaller % (10%) → QD extends by a larger % (50%) → TR ↑.
- Inelastic (substitutes ↓, necessity): the producer increases price by a larger % (50%) → QD contracts by a smaller % (10%) → TR ↑.
Elastic (after price ↓)TR = Price × QtyTR = OP × aQTR = OPaQafter: OP₁ × bQ₁ = OP₁bQ₁ (larger)
Inelastic (after price ↑)TR = Price × QtyTR = OP × aQTR = OPaQTR = OP₁ × bQ₁ = OP₁bQ₁
Definition: Price discrimination is charging different prices to different customers for the same product; the reason is not associated with the cost of the product and is due to lack of information.
Remember: the producer’s aim is to maximise total revenue — so he identifies the elasticity of demand and plans the pricing strategy accordingly.
7. How Price and Quantity relate to TR
Two graphs per case: Price vs TR (y = P, x = TR) and TR vs Qty (y = TR, x = Qty).
| Price & TR | Qty & TR | |
|---|---|---|
| Elastic | −ve relationship | +ve relationship |
| Inelastic | +ve relationship | −ve relationship |
| Perfectly elastic | no relationship | +ve relationship |
| Perfectly inelastic | +ve relationship | no relationship |
| Unitary | no relationship | no relationship |
Reasons (write these in exams)
- Elastic — Price & TR negative: when price decreases by a smaller %, QD (extends) by a larger % → TR ↑.
- Elastic — Qty & TR positive: price decreases by a smaller %, so QD rises by a larger % → TR ↑.
- Inelastic — Price & TR positive: when price increases by a larger %, QD contracts by a smaller % → TR ↑.
- Inelastic — Qty & TR negative: price increases by a larger %, so QD contracts by a smaller % → TR ↑.
Exam tip: underline price, total revenue, positive/negative, larger / smaller percentage and quantity demanded — these are the marking words the teacher highlighted in red.
8. How to Increase TR through PED
| Case | PED | Reason | Price | QD | TR | % |
|---|---|---|---|---|---|---|
| 1) Elastic | > 1 | substitutes ↑, luxury | ↓ | ↑ | ↑ | 10% / 50% |
| 2) Inelastic | < 1 | substitutes ↓, necessity | ↑ | ↓ | ↑ | 50% / 10% |
| 3) Perfectly elastic | ∞ | 1000s of substitutes, same product | – | ↑ | ↑ | 10% / 10% |
| 4) Perfectly inelastic | 0 | no substitute available | ↑ | – | ↑ | 50% / 50% |
| 5) Unitary | 1 | equal responsiveness | ↓ | ↑ | – (unchanged) | 10% / 10% |
Note: total revenue can never be increased in the case of unitary elastic demand, due to equal responsiveness — TR will remain unchanged.
✓ Quick Recap — whole chapter
- PED = % Δ QD ÷ % Δ Price; % change = (New − Old) ÷ Old × 100; ignore the − sign.
- > 1 elastic (flat, luxury, substitutes ↑) · < 1 inelastic (steep, necessity, substitutes ↓) · = 1 unitary (rect. hyperbola) · ∞ perfectly elastic (horizontal) · 0 perfectly inelastic (vertical).
- Factors: substitutes · type of product · time period (short run IED, long run ED) · addiction · % of income.
- TR = Price × Qty = consumer expenditure = producer revenue.
- Elastic → cut price; inelastic → raise price; unitary → TR unchanged. Aim: TR maximise.
- Price discrimination = different prices to different customers for the same product (not cost-based, lack of information).