In simple terms
A friendly intro before the formal notes — no formulas yet.
The Stretchiness of Demand
Elasticity puts a number on how much buyers react. Price elasticity (PED) asks: when the price moves, how strongly does quantity demanded move? Income elasticity (YED) asks the same about a change in income. A big reaction means demand is 'stretchy' (elastic); a small reaction means it is 'stiff' (inelastic).
Picture a bungee cord and a steel chain. Pull each with the same force: the bungee stretches a long way, the chain barely moves. Demand for a designer handbag is like the bungee — nudge the price up and buyers vanish (elastic). Demand for table salt is like the chain — double the price and people buy almost the same amount (inelastic).
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Turn the raw numbers into percentages: % change in quantity, and % change in price (for PED) or income (for YED).
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Divide to get the elasticity value, and keep the sign — it carries meaning.
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Classify: for PED use the size of the number (above or below 1); for YED the sign (positive or negative) comes first, then the size.
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Interpret in context — for a firm, feed PED into the total-revenue test to decide whether raising or cutting price earns more.
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Full topic notes
Formal explanation with the rigour you need for the exam.
Price elasticity of demand (PED)
Price elasticity of demand (PED) measures how responsive the quantity demanded of a good is to a change in its OWN price. Firms use it to set revenue-maximising prices; governments use it to predict how taxes and subsidies will change behaviour and tax revenue. It is the ratio of two percentage changes, so it is a pure number with no units.
Because the law of demand makes price and quantity demanded move in opposite directions, the numerator and denominator carry opposite signs and PED is almost always NEGATIVE. We classify demand by the size of the number (its absolute value, written |PED|), but on Paper 3 you should still state the sign — it shows the marker you understand the direction of the response, not just its size.
Elastic demand (|PED| > 1): quantity demanded changes by a LARGER percentage than price — buyers are responsive; the demand curve is relatively flat.
Inelastic demand (0 < |PED| < 1): quantity demanded changes by a SMALLER percentage than price — buyers are unresponsive; the demand curve is relatively steep.
Unit elastic demand (|PED| = 1): quantity demanded changes by exactly the same percentage as price.
Perfectly inelastic demand (PED = 0): quantity demanded does not change at all — a vertical demand curve (approached by, e.g., a life-saving drug with no substitute).
Perfectly elastic demand (|PED| = ∞): at one price buyers take any quantity, but any rise sends quantity demanded to zero — a horizontal demand curve (faced by a single firm in perfect competition).
The determinants of PED
Whether a good is elastic or inelastic is not random — a handful of factors drive it. A useful memory aid is SPLAT. In an exam you must APPLY each factor to the good in the question rather than just list them.
Substitutes — the more numerous and closer the substitutes, the MORE elastic demand. If one brand of petrol rises in price, drivers switch brands easily.
Proportion of income — goods taking a large share of income (cars, holidays) tend to be MORE elastic, because buyers feel the price change keenly; cheap items like salt are inelastic.
Luxury vs necessity — necessities (basic food, water) are inelastic; luxuries (designer goods) are elastic.
Addictiveness / habit — addictive or habitual goods (cigarettes, caffeine) are very inelastic; buyers keep buying despite price rises.
Time period — demand grows MORE elastic over time, as consumers find substitutes and adjust habits once a price change has settled in.
When a question asks for the determinants of PED for a named good, apply them to context. For 'petrol' you would argue demand is inelastic in the short run (few substitutes for fuel as a whole, needed for existing cars) but that a specific BRAND of petrol is elastic (rival stations are close substitutes). Naming the determinant and linking it to the good is what earns the marks.
PED and total revenue: the total-revenue test
The most useful application of PED for a firm is its effect on total revenue (TR = Price × Quantity). Because a price change moves P one way and Q the other, the outcome for TR depends entirely on which change is proportionally bigger — that is, on PED. This link is the total-revenue test.
If demand is elastic (|PED| > 1), price and total revenue move in OPPOSITE directions. To raise revenue, CUT the price — the large rise in quantity more than offsets the lower price.
If demand is inelastic (|PED| < 1), price and total revenue move in the SAME direction. To raise revenue, RAISE the price — quantity falls only a little.
If demand is unit elastic (|PED| = 1), a price change leaves total revenue UNCHANGED — the percentage fall in quantity exactly cancels the percentage rise in price.
The test also works in reverse: observe how TR responds to a known price change to DEDUCE whether demand is elastic or inelastic.
Income elasticity of demand (YED)
Income elasticity of demand (YED) measures how responsive quantity demanded is to a change in consumer INCOME (Y), holding price constant. It tells a firm how its sales will move over the business cycle — booming in a recovery, or holding steady in a downturn. Here the SIGN of the answer is the first thing to read, because it separates normal goods from inferior goods.
Normal goods (YED > 0): demand RISES as income rises. Most goods are normal.
– Necessities (0 < YED < 1): income inelastic — demand grows, but by a smaller percentage than income (e.g. basic groceries).
– Luxuries (YED > 1): income elastic — demand grows by a LARGER percentage than income (e.g. foreign holidays, fine dining).
Inferior goods (YED < 0): demand FALLS as income rises, because wealthier consumers switch to preferred alternatives (e.g. from budget noodles to restaurant meals, or from the bus to a car).
Common mistakes examiners penalise
Elasticity is the first genuinely quantitative tool in the course, and Paper 3 will keep testing it: cross-price elasticity, price elasticity of supply, and tax incidence all rest on the same percentage-change machinery you have used here. Master the discipline now — percentages first, formula second, sign always, interpretation last — and every later calculation becomes a variation on a method you already own.
Dropping the sign. On Paper 3, PED should be reported as negative and YED with its actual sign. A bare '1' instead of '−1', or a YED with no sign, can cost the accuracy mark because the sign carries meaning.
Confusing the elastic/inelastic threshold. The dividing line is |PED| = 1, not 0. |PED| between 0 and 1 is INELASTIC; above 1 is ELASTIC. Mislabelling 0.5 as 'elastic' is a classic error.
Getting the total-revenue direction backwards. For INELASTIC demand, price and TR move together (raise price to raise TR); for ELASTIC demand they move oppositely (cut price to raise TR). Reversing these loses application marks.
Mixing up YED sign and PED sign. A negative PED is normal and expected; a negative YED specifically means an INFERIOR good. Never call a good 'inferior' because its PED is negative.
Not showing working. Paper 3 awards method marks (M) for the percentage-change and formula steps. Writing only a final number forfeits the M marks even if the answer is right — always show %ΔQ, %ΔP or %ΔY, then the division.
Assuming constant PED along a straight-line demand curve. A linear demand curve is elastic at the top, unit elastic at the midpoint and inelastic at the bottom — the slope is constant but the elasticity is not.
Worked examples
See the formulas applied — reveal one step at a time, like the exam.
When the price of a good falls from 16, quantity demanded rises from 400 to 480 units. Calculate the PED and state whether demand is elastic or inelastic, then explain what happens to total revenue. [4 marks]
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Step 1 — % change in quantity demanded (method): %ΔQd = (ΔQd ÷ original Qd) × 100 = [(480 − 400) ÷ 400] × 100 = (80 ÷ 400) × 100 = +20%
In a town, average annual income rises from 31,500. Over the same period annual demand for restaurant meals rises from 5,000 to 5,500, while demand for frozen pizzas falls from 8,000 to 7,800.
(a) Calculate the YED for restaurant meals. [2] (b) Calculate the YED for frozen pizzas. [2] (c) Classify each good using your results. [2]
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(a) Restaurant meals
- %ΔY = [(31,500 − 30,000) ÷ 30,000] × 100 = (1,500 ÷ 30,000) × 100 = +5% [M1 method]
- %ΔQd = [(5,500 − 5,000) ÷ 5,000] × 100 = (500 ÷ 5,000) × 100 = +10%
- YED = +10% ÷ +5% = +2 [A1 value with sign]
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Price elasticity of demand (PED)
A measure of how responsive the quantity demanded of a good is to a change in its OWN price. PED = %ΔQd ÷ %ΔP.
Key takeaways
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Elastic demand (|PED| > 1): quantity demanded changes by a LARGER percentage than price — buyers are responsive; the demand curve is relatively flat.
- ✓
Inelastic demand (0 < |PED| < 1): quantity demanded changes by a SMALLER percentage than price — buyers are unresponsive; the demand curve is relatively steep.
- ✓
Unit elastic demand (|PED| = 1): quantity demanded changes by exactly the same percentage as price.
- ✓
Perfectly inelastic demand (PED = 0): quantity demanded does not change at all — a vertical demand curve (approached by, e.g., a life-saving drug with no substitute).
- ✓
Perfectly elastic demand (|PED| = ∞): at one price buyers take any quantity, but any rise sends quantity demanded to zero — a horizontal demand curve (faced by a single firm in perfect competition).
Practice — then mark it
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Get a Paper 3 elasticity calculation marked: compute PED, classify demand, and apply the total-revenue test
Get a Paper 3 elasticity calculation marked: compute PED, classify demand, and apply the total-revenue test
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