What is price elasticity of demand?
Price elasticity of demand (PED) measures how much the quantity demanded changes when the price changes. It compares percentage changes, so it works for any unit or currency.
- Elastic (PED > 1): quantity changes by a bigger % than price. Flat-looking demand curve.
- Inelastic (PED < 1): quantity changes by a smaller % than price. Steep-looking curve.
- Unit elastic (PED = 1): the same % change.
- Extremes: perfectly inelastic (PED = 0, vertical curve, quantity never changes) and perfectly elastic (PED = ∞, horizontal curve).
Because price and quantity demanded move in opposite directions, PED is negative; we usually ignore the minus sign and compare the size.
Factors affecting PED
- Substitutes: many close substitutes → elastic (one brand of cola). Few → inelastic (petrol, tap water).
- Necessity or luxury: necessities (salt, basic food, medicine) are inelastic; luxuries (holidays, jewellery) are elastic.
- Share of income: a tiny share (a box of matches) → inelastic; a big share (a car, rent) → more elastic.
- Time: in the long run people find substitutes (switch to an electric scooter), so demand becomes more elastic.
- Habit and addiction: cigarettes and coffee for regular users are inelastic.
- How widely the good is defined: 'food' is inelastic, but 'one brand of biscuits' is elastic.
Calculating PED
PED = % change in quantity demanded ÷ % change in price
% change = (new − old) ÷ old × 100.
Example: price falls from $12 to $9 and quantity rises from 60 to 80.
- % change in price = (9 − 12) ÷ 12 × 100 = −25%.
- % change in quantity = (80 − 60) ÷ 60 × 100 = +33.3%.
- PED = 33.3 ÷ −25 = −1.33 → size 1.33 > 1 → elastic.
You can also work backwards: if PED = 0.5 and price rises 10%, quantity falls 0.5 × 10 = 5%.
PED and total revenue
Total revenue (TR) = price × quantity sold, the area of the rectangle under the demand curve.
- Elastic demand: a price cut raises quantity by a bigger %, so TR rises; a price rise makes TR fall.
- Inelastic demand: a price rise loses only a few sales, so TR rises; a price cut makes TR fall.
- Unit elastic: TR stays the same.
Firms use this to set prices (discounts on elastic goods); governments tax inelastic goods (fuel, tobacco) because sales and tax income stay high.
Price elasticity of supply (PES)
PES = % change in quantity supplied ÷ % change in price. It is positive, because a higher price leads firms to supply more.
Example: price rises from ₹50 to ₹60 (+20%) and quantity supplied rises from 1,000 to 1,100 (+10%). PES = 10 ÷ 20 = 0.5 → inelastic.
Factors affecting PES:
- Spare capacity: idle machines and workers → elastic.
- Stocks: goods that can be stored (tinned food) → elastic; perishables (fresh fish) → inelastic.
- Time: in the short run factories and farms are fixed; in the long run firms can build more → more elastic.
- Ease of getting inputs and factors: skilled workers or rare materials that are hard to get → inelastic.
- Production time: crops and buildings take a long time → inelastic; T-shirts or apps can be made quickly → elastic.
Try it
Make a list of 6 things your family buys. Mark each one E (you would buy much less if it cost 20% more) or I (you would still buy about the same). Which ones are necessities with no substitute? Then use the last 3D step: choose salt, raise the price and watch revenue rise; choose cola and watch it fall.
Key formulas and definitions
- % change = (new − old) ÷ old × 100
- PED = % change in quantity demanded ÷ % change in price
- PES = % change in quantity supplied ÷ % change in price
- PED > 1 elastic; PED < 1 inelastic; PED = 1 unit elastic; 0 perfectly inelastic
- Total revenue = price × quantity
- Elastic: price ↓ → TR ↑. Inelastic: price ↑ → TR ↑
Worked examples
1. The price of a bus ticket rises from $2.00 to $2.20 and daily passengers fall from 5,000 to 4,800. Find PED.
%ΔP = 0.20 ÷ 2.00 × 100 = +10%. %ΔQ = −200 ÷ 5,000 × 100 = −4%. PED = −4 ÷ 10 = −0.4 → 0.4, inelastic.
2. A shop cuts the price of headphones from ₹2,000 to ₹1,600 and sales rise from 50 to 80 a week. Find PED and say what happened to revenue.
%ΔP = −400 ÷ 2,000 = −20%. %ΔQ = 30 ÷ 50 = +60%. PED = 60 ÷ 20 = 3, elastic. TR before = 2,000 × 50 = ₹1,00,000; after = 1,600 × 80 = ₹1,28,000. Revenue rose, as expected for elastic demand.
3. PED for petrol is 0.2. The price rises by 15%. By what % does quantity demanded fall?
%ΔQ = PED × %ΔP = 0.2 × 15 = 3%. Quantity falls by 3%.
4. The price of wheat rises from $200 to $250 a tonne and farmers' supply rises from 800 to 900 tonnes. Find PES.
%ΔP = 50 ÷ 200 = +25%. %ΔQs = 100 ÷ 800 = +12.5%. PES = 12.5 ÷ 25 = 0.5, inelastic.
5. A museum has inelastic demand for tickets. Should it raise or lower its price to raise revenue? Why?
Raise it. With inelastic demand, the % fall in visitors is smaller than the % rise in price, so price × quantity goes up.
6. Explain why the supply of new houses is inelastic in the short run but more elastic in the long run.
In the short run building takes months and land, workers and permits are limited, so supply cannot rise much. Over years firms can train workers, get land and build, so supply responds more.
Common mistakes
- Dividing the wrong way: PED is % change in QUANTITY ÷ % change in PRICE, not the other way round.
- Using absolute changes (20 units, ₹3) instead of percentage changes.
- Thinking 'inelastic' means quantity does not change at all. It only changes by a smaller % than price (perfectly inelastic is the special case).
- Saying a price cut always raises revenue. It does only when demand is elastic.