Price elasticity of demand: how strongly consumers react to price changes
Price elasticity of demand, usually written as PED, measures how responsive quantity demanded is when price changes. In simple words, PED asks: if price changes, do customers change their buying by a lot or only by a little?
Key idea: Demand is elastic when consumers react strongly to price changes. Demand is inelastic when consumers do not react very much to price changes.
1. How to calculate PED
The formula compares the percentage change in quantity demanded with the percentage change in price:
PED = percentage change in quantity demanded ÷ percentage change in price
Because price and demand usually move in opposite directions, PED often gives a negative answer. For example, when price rises, quantity demanded normally falls. In many exam answers, the negative sign is kept, but when classifying elasticity, focus mainly on the size of the number.
In the example above, the cinema ticket price rises from $10 to $11, which is a 10% increase. Demand falls from 3500 to 3325 customers, which is a 5% decrease. Therefore, PED = -5 ÷ 10 = -0.5. The size of 0.5 shows that demand is price inelastic.
2. Price inelastic demand
Demand is price inelastic when a change in price causes a smaller percentage change in quantity demanded. This means customers still buy the product even when the price changes. Products such as petrol, salt, cigarettes and some medicines often have inelastic demand because consumers may see them as necessary, addictive or hard to replace.
Easy rule: A steep demand curve usually suggests demand is inelastic. Price changes a lot, but quantity demanded changes only a little.
3. Price elastic demand
Demand is price elastic when a change in price causes a larger percentage change in quantity demanded. This often happens when there are many substitutes or the product is not essential. Examples include soft drinks, restaurant meals, airline travel and many luxury goods.
Easy rule: A flatter demand curve usually suggests demand is elastic. A small price change can cause a large change in quantity demanded.
4. Special cases of PED
Some demand curves show special types of elasticity. These are useful because they help students understand the extremes.
Perfectly price inelastic demand
Demand is perfectly price inelastic when quantity demanded does not change at all, even if price changes. The PED value is 0. In real life, this is rare, but some urgent medicines may be very close to perfectly inelastic because patients still need them regardless of price.
Perfectly price elastic demand
Demand is perfectly price elastic when consumers will buy only at one price. If the price rises even slightly above that level, quantity demanded falls to zero. This is shown by a horizontal demand curve.
Unitary price elastic demand
Demand has unitary price elasticity when the percentage change in quantity demanded is exactly equal to the percentage change in price. The PED value is 1. This means total revenue stays the same when price changes.
5. PED and sales revenue
Businesses study PED because it helps them decide whether increasing or decreasing price is likely to raise sales revenue. Sales revenue is calculated as:
Sales revenue = Price × Quantity sold
When demand is price inelastic
If demand is price inelastic, a price increase can increase total revenue. This is because quantity demanded falls by a smaller proportion than the price rises. The extra money earned from the higher price is greater than the money lost from selling fewer units.
When demand is price elastic
If demand is price elastic, a price cut can increase total revenue. This is because quantity demanded rises by a greater proportion than the price falls. The business loses some revenue from the lower price, but gains more revenue from selling many more units.
6. What makes demand elastic or inelastic?
| Factor | Effect on PED | Simple explanation |
|---|---|---|
| Number of substitutes | More substitutes = more elastic | Consumers can easily switch to another product if price rises. |
| Necessity or luxury | Necessities are more inelastic; luxuries are more elastic | People keep buying necessities, but can avoid luxuries. |
| Proportion of income spent | Large share of income = more elastic | Consumers notice big expensive purchases more than small cheap items. |
| Time period | Demand is usually more elastic in the long run | Consumers need time to find substitutes or change habits. |
| Habit-forming products | More inelastic | Consumers may continue buying even after price increases. |
7. Exam method for PED questions
- Write the formula: PED = % change in quantity demanded ÷ % change in price.
- Calculate carefully: work out the percentage change in quantity demanded and price.
- Classify the answer: PED greater than 1 = elastic; PED less than 1 = inelastic; PED equal to 1 = unitary.
- Explain the meaning: say whether consumers are very responsive or not very responsive to the price change.
- Link to revenue if needed: for elastic demand, a price cut may raise revenue; for inelastic demand, a price rise may raise revenue.
Quick check
- If PED is 2.5, demand is elastic.
- If PED is 0.4, demand is inelastic.
- If PED is 1, demand is unitary elastic.
- If price rises and demand is inelastic, total revenue is likely to increase.
- If price falls and demand is elastic, total revenue is likely to increase.
