Syllabus points
- Calculate and interpret price elasticity of demand (PED).
- Explain the determinants of PED and the link to total revenue.
- Calculate and interpret income elasticity of demand (YED) and classify goods.
Price elasticity of demand (PED)
PED measures how responsive quantity demanded is to a change in price.
PED = percentage change in quantity demanded ÷ percentage change in price
PED is negative (demand slopes down); we discuss the absolute value:
- Elastic (|PED| > 1): quantity is very responsive.
- Inelastic (|PED| < 1): quantity is unresponsive.
- Unit elastic (|PED| = 1): proportional response.
Key definitions
| Term | Exam-ready definition |
|---|---|
| PED | Responsiveness of quantity demanded to a change in price. |
| YED | Responsiveness of demand to a change in income. |
| Normal good | Positive YED — demand rises as income rises. |
| Inferior good | Negative YED — demand falls as income rises. |
Determinants of PED
- Substitutes — more (and closer) substitutes make demand more elastic.
- Necessity vs luxury — necessities are inelastic; luxuries elastic.
- Proportion of income — goods taking a large share of income are more elastic.
- Time — demand is more elastic over the long run as consumers adjust.
- Addictiveness/habit — makes demand inelastic.
PED and total revenue
For a price rise: if demand is inelastic, revenue rises (quantity falls proportionately less); if elastic, revenue falls. This matters for firms setting prices and for governments taxing goods.
Inelastic demand + price rise → total revenue rises. Elastic demand + price rise → total revenue falls.
Income elasticity of demand (YED)
YED = percentage change in demand ÷ percentage change in income
- Normal goods: YED > 0 (necessities 0<YED<1; luxuries YED>1).
- Inferior goods: YED < 0 (demand falls as incomes rise).
YED helps firms and economies anticipate how demand shifts as incomes grow.
Worked example
A café raises price by 10% and quantity demanded falls by 20%. PED = −20% ÷ 10% = −2 (elastic). Because demand is elastic, total revenue falls: the proportionate drop in quantity outweighs the price rise. Close substitutes give customers a reason to switch.
Common exam mistakes
- Forgetting PED is negative and misclassifying by sign instead of absolute value.
- Saying a price rise "always" raises revenue — it depends on elasticity.
- Confusing PED with YED.
Exam technique
Always calculate, then *interpret*: state elastic/inelastic and explain the decision it affects (pricing, tax revenue, farm incomes). Note that PED varies along a straight-line demand curve.
Quick revision
- PED = %ΔQd ÷ %ΔP; |PED|>1 elastic, <1 inelastic.
- Inelastic + price rise → revenue up.
- YED: + normal, − inferior; luxuries YED>1.