Cambridge IGCSE Economics 0455
Syllabus points
- Define and calculate price elasticity of demand (PED).
- Explain the determinants of PED.
- Explain the link between PED and a firm's total revenue.
What is PED?
Price elasticity of demand (PED) measures how responsive quantity demanded is to a change in price.
PED = percentage change in quantity demanded ÷ percentage change in price
We look at the size (ignoring the minus sign):
- Elastic (greater than 1): quantity is very responsive to price.
- Inelastic (less than 1): quantity changes little when price changes.
Key definitions
| Term | Definition |
|---|---|
| PED | Responsiveness of quantity demanded to a change in price. |
| Elastic demand | A price change causes a larger percentage change in quantity demanded. |
| Inelastic demand | A price change causes a smaller percentage change in quantity demanded. |
Determinants of PED
- Substitutes — more (and closer) substitutes make demand more elastic.
- Necessity or luxury — necessities are inelastic; luxuries elastic.
- Proportion of income — goods taking a big share of income are more elastic.
- Time — demand becomes more elastic over time as buyers adjust.
- Addiction or habit — makes demand inelastic.
PED and total revenue
Total revenue = price × quantity. The effect of a price change on revenue depends on PED:
- If demand is inelastic, raising the price increases revenue (quantity falls by less than price rises).
- If demand is elastic, raising the price reduces revenue.
Inelastic + price rise → revenue up. Elastic + price rise → revenue down.
Worked example
A bus company raises fares by 10% and passenger numbers fall by 4%. PED = 4% ÷ 10% = 0.4 (inelastic). Because demand is inelastic (few substitutes for many commuters), total revenue rises. This is why firms with inelastic demand can raise prices to increase revenue.
Common exam mistakes
- Forgetting the formula or dividing the wrong way round.
- Saying a price rise always raises revenue — it depends on PED.
- Confusing PED with elasticity of supply.
Exam technique
Calculate, then interpret: state elastic or inelastic and explain the decision it affects (pricing, government tax revenue, farmers' incomes).
Quick revision
- PED = %ΔQd ÷ %ΔP; >1 elastic, <1 inelastic.
- Inelastic + price rise → total revenue rises.
- Determinants: substitutes, necessity, income share, time, habit.