Price Elasticity of Demand (PED) — Full Chapter Notes
(Textbook-Aligned)
These notes follow your textbook structure exactly (from section 11.1 to 11.7 and extra parts on elasticity
types and decision-making). Each concept is explained clearly, with examples and connections to exam
skills.
11.1 Definition of price elasticity of demand
Price elasticity of demand (PED) measures how much the quantity demanded of a good responds to a
change in its price, assuming all other factors remain constant (ceteris paribus).
Formula: PED = percentage change in quantity demanded ÷ percentage change in price
PED is usually negative, because price and quantity demanded usually move in opposite directions. In many
answers, we focus on the absolute value (|PED|), but it's important to know that the sign shows the inverse
relationship.
11.2 Calculating PED
To calculate PED, follow these steps:
1. Find the percentage change in quantity demanded: (New quantity − Original quantity) ÷ Original quantity ×
100
2. Find the percentage change in price: (New price − Original price) ÷ Original price × 100
3. Divide: PED = (% change in quantity demanded) ÷ (% change in price)
Example: If the price falls from $10 to $9 (−10%) and demand rises from 200 units to 240 units (+20%), then
PED = +20 ÷ −10 = −2. This means demand is elastic.
11.3 Interpretation of PED
PED tells us how responsive consumers are to price changes:
- If PED > 1 (ignoring minus): Demand is elastic. Quantity demanded changes by a larger percentage than
the price.
- If PED < 1: Demand is inelastic. Quantity demanded changes by a smaller percentage than the price.
- If PED = 1: Unit elasticity. Quantity and price change by the same percentage.
The minus sign shows that the relationship is inverse: when price rises, quantity demanded falls.
11.4 Elastic and inelastic demand
Elastic demand: Price and total revenue move in opposite directions. If price goes up, total revenue goes
down. If price goes down, total revenue goes up.
Inelastic demand: Price and total revenue move in the same direction. If price increases, total revenue also
increases. If price falls, total revenue falls too.
Unit elasticity: Total revenue stays the same when price changes.
Important exam point: Always explain the connection between PED and total revenue (TR = Price ×
Quantity).
Other degrees of elasticity
Perfectly elastic demand: Consumers will only buy at one price. Any increase in price causes quantity
demanded to fall to zero. The demand curve is horizontal.
Perfectly inelastic demand: Quantity demanded stays the same no matter the price. The demand curve is
vertical. Example: life-saving medicine.
Unit elastic demand: A percentage change in price leads to an equal percentage change in quantity
demanded. TR remains the same.
11.5 Determinants of price elasticity of demand
Several factors affect whether demand is elastic or inelastic:
- Availability of substitutes: More substitutes mean demand is more elastic.
- Proportion of income: If a product takes up a large share of income, demand tends to be elastic.
- Luxury vs necessity: Luxuries usually have elastic demand; necessities have inelastic demand.
- Addiction/habit: Addictive goods like cigarettes have inelastic demand.
- Time: Demand becomes more elastic over time as consumers have more time to find alternatives.
- Whether the purchase can be postponed: If it can, demand is more elastic.
- Market definition: Narrowly defined markets (e.g., brand of phone) have more elastic demand than broad
markets (e.g., phones in general).
Important: PED can vary over time and between countries depending on income, culture and availability.
11.6 Changes in PED
PED can change along a demand curve and over time:
- On a straight-line demand curve, PED is not constant. At higher prices and lower quantities, demand is
more elastic. At lower prices and higher quantities, demand is more inelastic.
- As price rises, demand becomes more elastic because consumers notice the change more and start
reacting.
- Over time, PED increases because more substitutes appear, consumers have more time to switch, and
habits can change.
- A shift in the demand curve can also affect PED at a specific price. When demand increases, PED may fall
(becomes more inelastic). When demand falls, PED may rise (more elastic).
PED and the total spending on a product and revenue gained
Total spending (or total revenue) is calculated by multiplying the price of the product by the quantity
demanded: TR = P × Q.
How PED affects total revenue when price changes:
- If demand is elastic (|PED| > 1), a rise in price causes a larger percentage fall in quantity demanded. As a
result, total revenue falls. A price cut will increase total revenue.
- If demand is inelastic (|PED| < 1), a rise in price causes only a small fall in quantity demanded. Total
revenue increases. A price cut will reduce total revenue.
- If demand is unit elastic (|PED| = 1), total revenue stays the same whether price rises or falls.
In the case of perfectly elastic demand, a price rise results in total revenue falling to zero. In the case of
perfectly inelastic demand, quantity demanded does not change, so total revenue changes in the same
direction as price.
This concept helps businesses and governments make pricing and tax decisions. For example, governments
tax inelastic goods to raise more revenue, and firms avoid cutting prices when demand is inelastic.
11.7 Implications of PED for decision making
For producers
- If demand is elastic, lowering the price increases total revenue.
- If demand is inelastic, raising the price increases total revenue.
- Firms can try to make demand more inelastic through advertising, branding, and improving product loyalty.
- When planning a price change, a firm should consider how large the change in quantity will be to predict
revenue.
For governments
- When taxing goods, governments raise more revenue from products with inelastic demand (like petrol or
cigarettes).
- If the aim is to reduce consumption, taxes work better when demand is elastic. If demand is inelastic, other
measures may be needed.
- PED helps decide which products to tax, subsidise, or regulate.
Key points to remember
- PED measures the responsiveness of demand to a change in price (as a percentage).
- PED = % change in quantity demanded ÷ % change in price (usually negative).
- Elastic > 1, Inelastic < 1, Unit = 1 (by absolute value).
- PED affects total revenue: elastic → price cut raises revenue; inelastic → price rise raises revenue.
- Time, substitutes, income share, necessity/luxury, and market definition all affect PED.
- Use PED when making decisions on pricing, taxation, and predicting consumer responses.