Interpret PED values — elastic, inelastic, unit elastic, and the extreme cases
Explain the determinants of PED including substitutes, necessity, and habit
Link PED to total revenue decisions and government tax policy
Definition
What is Price Elasticity of Demand?
Key Formula
PED = % change in Qd ÷ % change in Price
PED measures the responsiveness of quantity demanded to a change in price. The value is always negative — because of the inverse relationship between price and demand (Law of Demand). Economists often refer to the magnitude (absolute value) when comparing elasticities.
ELASTIC DEMAND
|PED| > 1 — quantity demanded changes by more than the price change. Consumers are very responsive.
INELASTIC DEMAND
|PED| < 1 — quantity demanded changes by less than the price change. Consumers are not very responsive.
Worked Example
Calculating PED — Step by Step
THE FORMULA
PED = % change in Qd
÷ % change in Price
% change = (New − Old) ÷ Old × 100
INTERPRETATION
PED = −1.5 means demand is elastic (|1.5| > 1). A 1% price rise → 1.5% fall in Qd. Consumers are quite responsive to this price change.
NUMERIC EXAMPLE
Price: £10 → £12 (+20%)
Qd: 200 → 140 (−30%)
PED = −30% ÷ +20%
PED = −1.5
|−1.5| > 1 → Elastic demand
EXAM TIP
Always show your working. State the formula, substitute values, and interpret the sign and magnitude.
PED Values
The PED Spectrum
PED = 0
Perfectly Inelastic
Quantity doesn't change at all with price. e.g. Insulin — diabetics must have it regardless of cost.
0 > PED > −1
Inelastic
Qd changes less than price. e.g. Petrol — necessity, few substitutes, short-run.
PED = −1
Unit Elastic
Qd changes by exactly the same % as price. Total Revenue unchanged.
PED < −1
Elastic
Qd changes more than price. e.g. Package holidays — luxury, many substitutes.
PED = −∞
Perfectly Elastic
Any price rise → Qd drops to zero. e.g. Commodity markets — identical products, perfect info.
Remember: "Elastic" = sensitive to price (like elastic bands — they stretch a lot). "Inelastic" = insensitive to price (like a brick — barely moves).
Diagram
Visualising Elastic vs Inelastic Demand
STEEP = INELASTIC
A large price change produces only a small change in Qd. The curve is nearly vertical. Examples: petrol, cigarettes, insulin.
SHALLOW = ELASTIC
A small price change produces a large change in Qd. The curve is nearly horizontal. Examples: holidays, luxury goods, branded goods with close substitutes.
Determinants
What Determines PED?
Number of close substitutes — More substitutes → more elastic. If Coca-Cola raises price, consumers switch to Pepsi easily.
Necessity vs luxury — Necessities (food, medicine) are inelastic; luxuries (foreign holidays) are elastic.
Habit-forming / addictive goods — Cigarettes, alcohol are highly inelastic because demand is driven by dependency, not rational choice.
Time period — Demand is more inelastic in the short run. Over time, consumers find alternatives → becomes more elastic.
Proportion of income — High-proportion goods (rent, cars) are more elastic; low-proportion goods (salt, matches) are inelastic.
Business Application
PED and Total Revenue
Total Revenue (TR) = Price × Quantity
PED Type
Price Change
Effect on TR
Why?
Elastic (|PED|>1)
↑ Rise
↓ TR falls
Qd falls proportionally MORE than price rises
Elastic (|PED|>1)
↓ Fall
↑ TR rises
Qd rises proportionally MORE than price falls
Inelastic (|PED|<1)
↑ Rise
↑ TR rises
Qd falls proportionally LESS than price rises
Inelastic (|PED|<1)
↓ Fall
↓ TR falls
Qd rises proportionally LESS than price falls
Rule: If demand is inelastic → raise price to increase TR. If demand is elastic → lower price to increase TR.
Real-World Application · Apple
Case Study: Apple iPhone & Inelastic Demand
WHAT HAPPENED (2018)
Apple raised iPhone prices by approximately 20% with the launch of iPhone XS. Despite fewer units sold, Apple's revenue increased. A textbook example of a firm exploiting inelastic demand.
WHY IS IPHONE DEMAND INELASTIC?
1. iOS ecosystem lock-in (apps, iCloud, iMessage) 2. Strong brand loyalty — switching cost is high 3. Perceived lack of like-for-like Android substitute 4. Status good — price rise may even increase appeal
PED ESTIMATE
Apple's iPhone PED is estimated at approximately −0.5 to −0.8. Since |PED| < 1, demand is inelastic. A price rise → TR rises. This is precisely why Apple's profit margins are among the highest in consumer electronics.
EVALUATION
PED is not fixed — if Android closes the quality gap or if incomes fall sharply (recession), Apple's pricing power could erode. PED varies across market segments too (budget buyers vs premium buyers).
Real-World Application · Policy
Case Study: UK Sugar Tax (2018)
THE SOFT DRINKS INDUSTRY LEVY
The UK government chose to tax sugary drinks precisely because demand is inelastic (PED estimated ≈ −0.3 to −0.6). With inelastic demand, a tax raises price but quantity falls only slightly — tax revenue is secured and health outcomes improve modestly.
THE UNEXPECTED OUTCOME
Rather than simply pass the tax on, manufacturers reformulated to avoid the tax bracket. Lucozade cut sugar content by 50%. Ribena also dramatically reduced sugar. This shows governments must consider supply-side responses, not just demand effects.
WHY GOVERNMENTS PREFER INELASTIC GOODS FOR TAX
If demand is elastic → tax causes large falls in quantity demanded → tax revenue lower than expected.
If demand is inelastic → quantity barely falls → tax revenue is predictable and large. Classic examples: tobacco, alcohol, petrol.
LIMITS OF THIS POLICY
PED is not permanent — reformulation changed the supply-side. The tax was actually so effective at changing behaviour that it partly undermined its own revenue goal. Inelastic today ≠ inelastic tomorrow.
Evaluation
Evaluating PED as a Concept
For (Strengths)
Helps firms set optimal prices to maximise total revenue
Allows governments to identify which goods to tax effectively
Provides a quantitative measure — can be estimated from data
Against (Limitations)
PED varies by market segment, income group, and time period
Difficult to measure accurately — requires good data on prices and quantities
Assumes ceteris paribus — in reality many factors change simultaneously
Elasticity can change over time as markets evolve (substitutes emerge)
Essay Tip: Always evaluate whether PED is constant or variable. Good answers note that PED differs across market segments (low-income vs high-income consumers) and across time horizons. The sugar tax example is excellent: inelastic demand assumed to be permanent — but producers adapted.
Glossary
Key Terms
PED
% change in Qd ÷ % change in Price. Always negative. Measures consumer responsiveness to price.
Elastic Demand
|PED| > 1. Consumers are very responsive to price changes. Qd changes by more than price.
Inelastic Demand
|PED| < 1. Consumers are not very responsive. Qd changes by less than price. e.g. petrol, insulin.
Unit Elastic
PED = −1. Qd changes by exactly the same % as price. Total Revenue stays constant.
Total Revenue
TR = Price × Quantity. Key metric for evaluating the impact of price changes on a firm's income.
Substitutes
More close substitutes → more elastic demand. Consumers can easily switch if price rises.
Necessity
A good required for basic living or with no alternatives. Tends to have inelastic demand.
Luxury Good
A non-essential good. Tends to have more elastic demand — consumers can cut back easily.
Summary · Topic 1.1
What You've Covered
WHAT PED MEASURES
›Responsiveness of Qd to price change
›Formula: % ΔQd ÷ % ΔP
›Always negative (inverse P–Q relationship)
›Steep curve = inelastic · Shallow = elastic
VALUES & INTERPRETATIONS
›PED = 0: Perfectly inelastic (insulin)
›0 > PED > −1: Inelastic (petrol)
›PED = −1: Unit elastic
›PED < −1: Elastic (holidays)
POLICY APPLICATIONS
›Inelastic → raise price → TR rises (Apple)
›Elastic → lower price → TR rises
›Governments tax inelastic goods (sugar, tobacco)
›PED varies — not fixed over time
Question 1 of 8 · Price Elasticity of Demand
Which formula correctly calculates Price Elasticity of Demand?
A
% change in Price ÷ % change in Qd
B
% change in Qd ÷ % change in Price
C
% change in Qs ÷ % change in Price
D
% change in Income ÷ % change in Qd
Answer · Question 1
Which formula correctly calculates Price Elasticity of Demand?
A
% change in Price ÷ % change in Qd
B
% change in Qd ÷ % change in Price
C
% change in Qs ÷ % change in Price
D
% change in Income ÷ % change in Qd
Correct: B. PED = % change in Quantity Demanded ÷ % change in Price. Option A is the inverse (incorrect order). Option C measures PES (supply, not demand). Option D is the YED formula.
Question 2 of 8 · Price Elasticity of Demand
Price rises from £5 to £6. Quantity demanded falls from 100 to 80. What is the PED?
A
−2.0 (elastic)
B
−1.0 (unit elastic)
C
−0.5 (inelastic)
D
+1.0 (unit elastic)
Answer · Question 2
Price rises from £5 to £6. Quantity demanded falls from 100 to 80. What is the PED?
A
−2.0 (elastic)
B
−1.0 (unit elastic)
C
−0.5 (inelastic)
D
+1.0 (unit elastic)
Correct: B. % change in Qd = (80−100)/100 × 100 = −20%. % change in Price = (6−5)/5 × 100 = +20%. PED = −20% ÷ +20% = −1.0. Unit elastic — TR stays unchanged. PED is negative (confirming the inverse relationship) not positive, so D is wrong.
Question 3 of 8 · Price Elasticity of Demand
Which good is most likely to have inelastic demand?
A
Package holidays
B
Petrol
C
Luxury sports cars
D
Designer handbags
Answer · Question 3
Which good is most likely to have inelastic demand?
A
Package holidays
B
Petrol
C
Luxury sports cars
D
Designer handbags
Correct: B. Petrol is a necessity (commuters must drive to work), has few close substitutes in the short run, and is habit-forming in terms of transport patterns. A, C, and D are all non-essentials with substitutes — meaning consumers can delay, switch, or forgo them if prices rise.
Question 4 of 8 · Price Elasticity of Demand
A firm faces inelastic demand for its product. It raises price by 10%. What happens to Total Revenue?
A
TR falls — fewer units are sold
B
TR is unchanged — unit elastic
C
TR rises — price rises more than Qd falls
D
TR falls — consumers switch to substitutes
Answer · Question 4
A firm faces inelastic demand for its product. It raises price by 10%. What happens to Total Revenue?
A
TR falls — fewer units are sold
B
TR is unchanged — unit elastic
C
TR rises — price rises more than Qd falls
D
TR falls — consumers switch to substitutes
Correct: C. With inelastic demand (|PED| < 1), a 10% price rise causes a less than 10% fall in Qd. TR = P × Q — the gain from higher price outweighs the loss from lower quantity. This is the core TR-PED relationship firms exploit when pricing inelastic goods.
Question 5 of 8 · Price Elasticity of Demand
Why does the UK government impose heavy taxes on cigarettes?
A
Elastic demand means large falls in smoking, maximising health benefits
B
Inelastic demand means tax revenue is secured without large falls in Qd
C
Unit elastic demand means TR stays constant — a revenue-neutral policy
D
The government wants to raise prices to encourage firms to reduce supply
Answer · Question 5
Why does the UK government impose heavy taxes on cigarettes?
A
Elastic demand means large falls in smoking, maximising health benefits
B
Inelastic demand means tax revenue is secured without large falls in Qd
C
Unit elastic demand means TR stays constant — a revenue-neutral policy
D
The government wants to raise prices to encourage firms to reduce supply
Correct: B. Cigarettes are habit-forming and addictive — demand is inelastic (PED ≈ −0.3 to −0.5). Taxing an inelastic good raises large revenue because consumers don't cut back much. Option A describes elastic demand, which would actually mean the tax is very effective at reducing smoking but less effective at raising revenue.
Question 6 of 8 · Price Elasticity of Demand
A good has PED = −2.5. What does this tell us about demand for this good?
A
Perfectly inelastic — quantity never changes
B
Inelastic — consumers are not very responsive
C
Elastic — consumers are highly responsive to price changes
D
Unit elastic — TR stays constant when price changes
Answer · Question 6
A good has PED = −2.5. What does this tell us about demand for this good?
A
Perfectly inelastic — quantity never changes
B
Inelastic — consumers are not very responsive
C
Elastic — consumers are highly responsive to price changes
D
Unit elastic — TR stays constant when price changes
Correct: C. |PED| = 2.5 which is greater than 1, so demand is elastic. A 1% price rise leads to a 2.5% fall in Qd. If this firm raises price, TR will fall (elastic: price↑ → TR↓). Perfectly inelastic = PED of 0; unit elastic = PED of exactly −1.
Question 7 of 8 · Price Elasticity of Demand
Which factor makes demand MORE elastic?
A
Very few close substitutes available
B
The good is habit-forming or addictive
C
Many close substitutes are available
D
The good is an essential necessity
Answer · Question 7
Which factor makes demand MORE elastic?
A
Very few close substitutes available
B
The good is habit-forming or addictive
C
Many close substitutes are available
D
The good is an essential necessity
Correct: C. Many close substitutes is the most important factor making demand elastic — if price rises, consumers can easily switch to alternatives. Options A, B, and D all make demand more inelastic: few substitutes mean no alternative; habit-forming goods are bought regardless of price; necessities must be purchased.
Question 8 of 8 · Price Elasticity of Demand
Apple raises the iPhone price by 15%. Quantity sold falls by 8%. What happens to Apple's total revenue?
A
TR falls — the price rise reduces Qd too much
B
TR rises — demand is inelastic so Qd falls proportionally less than price rises
C
TR is unchanged — this is a unit elastic good
D
TR falls — elastic demand means Qd is very responsive
Answer · Question 8
Apple raises the iPhone price by 15%. Quantity sold falls by 8%. What happens to Apple's total revenue?
A
TR falls — the price rise reduces Qd too much
B
TR rises — demand is inelastic so Qd falls proportionally less than price rises
C
TR is unchanged — this is a unit elastic good
D
TR falls — elastic demand means Qd is very responsive
Correct: B. PED = −8% ÷ +15% ≈ −0.53. Since |0.53| < 1, demand is inelastic. With inelastic demand, a price rise increases TR. The gain from higher price (×1.15) outweighs the loss from lower quantity (×0.92). This is exactly what Apple demonstrated in 2018 — raising prices and increasing revenue despite lower unit sales.