Price elasticity of demand (PED)
- PED measures how much quantity demanded responds to a change in price.
- PED = percentage change in quantity demanded ÷ percentage change in price. (PED is negative, so economists often ignore the minus sign.)
- Elastic demand (PED above 1): quantity changes by a bigger percentage than price. Inelastic demand (PED below 1): quantity changes by a smaller percentage.
- Example: price rises 10% and quantity demanded falls 20%. PED = −20 ÷ 10 = −2, which is elastic.
What affects PED
- Number of substitutes: more substitutes make demand more elastic.
- Necessities are inelastic; luxuries are more elastic.
- Proportion of income: goods taking a large share of income are more elastic.
- Time: demand becomes more elastic over time as people find alternatives.
- Addictive goods, such as cigarettes, are inelastic.
PED and revenue
- If demand is inelastic, raising the price increases total revenue. If demand is elastic, raising the price reduces total revenue.
- This is why governments tax goods with inelastic demand, such as petrol and cigarettes.
Price elasticity of supply (PES)
- PES = percentage change in quantity supplied ÷ percentage change in price.
- Supply is more elastic if firms have spare capacity, stocks, and more time to respond.
Key terms
- Price elasticity of demand
- How much quantity demanded responds to a change in price.
- Elastic demand
- Quantity demanded changes by a larger percentage than price.
- Inelastic demand
- Quantity demanded changes by a smaller percentage than price.
- Total revenue
- Price multiplied by quantity sold.
- Price elasticity of supply
- How much quantity supplied responds to a change in price.
- Spare capacity
- Being able to produce more with existing resources.
Practise Price elasticity of demand and supply: 10 questions