How strongly does the quantity demanded respond when the price changes?
Define price elasticity of demand, calculate it, and explain the factors that determine it
A clear O-Level answer on price elasticity of demand. The PED formula, how to tell elastic from inelastic demand, the factors that determine it, and how PED links to a firm's total revenue.
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What this dot point is asking
The syllabus wants you to define price elasticity of demand, calculate it from a price and quantity change, judge whether demand is elastic or inelastic, and explain the factors that determine it. The big idea is that the law of demand tells us quantity falls when price rises, but elasticity tells us by how much, which is exactly what firms and governments need to know.
The answer
What price elasticity of demand measures
The formula
Because price and quantity demanded move in opposite directions, PED is normally negative. At O-Level we usually look at its size, ignoring the minus sign, to judge how responsive demand is.
Elastic, inelastic and unit elastic
The size of PED tells us the type of demand:
- Price elastic demand: PED greater than . Quantity demanded changes by a larger percentage than price. Buyers are very responsive.
- Price inelastic demand: PED less than . Quantity demanded changes by a smaller percentage than price. Buyers are not very responsive.
- Unit elastic demand: PED equal to . Quantity demanded changes by the same percentage as price.
The factors that determine PED
Four main factors decide whether demand is elastic or inelastic:
- Availability of substitutes. Many close substitutes make demand elastic (buyers switch easily); few substitutes make it inelastic.
- Proportion of income spent on the good. A good taking a large share of income (a car) tends to have elastic demand; one taking a tiny share (salt) tends to be inelastic.
- Necessity or luxury. Necessities such as basic food have inelastic demand; luxuries have more elastic demand.
- Time period. Demand is usually more elastic over a longer period, because buyers have more time to find substitutes and change habits.
PED and total revenue
Total revenue is price times quantity sold. PED tells a firm what happens to revenue when it changes price:
- If demand is elastic, a price rise lowers total revenue (the large fall in quantity outweighs the higher price), while a price cut raises it.
- If demand is inelastic, a price rise raises total revenue (the small fall in quantity is outweighed by the higher price), while a price cut lowers it.
Examples in context
Example 1. Petrol has inelastic demand. Petrol has few close substitutes in the short run and is a necessity for drivers, so its demand is price inelastic. When the petrol price rises, the quantity demanded falls only a little, which is why fuel taxes raise large amounts of revenue.
Example 2. A particular brand of bubble tea has elastic demand. One brand of bubble tea has many close substitutes, other brands nearby, so its demand is elastic. If that brand raises its price while rivals do not, many customers switch, and its total revenue falls. The narrower the product, the more elastic its demand.
Try this
Cue. State the formula for price elasticity of demand. PED equals the percentage change in quantity demanded divided by the percentage change in price.
Cue. A good has a PED of . State whether demand is elastic or inelastic and what happens to revenue if the firm raises the price. The value is below , so demand is inelastic; a price rise therefore raises total revenue.
Cue. Explain why salt usually has inelastic demand. Salt has few close substitutes, is a necessity used in small amounts, and takes only a tiny share of income, so buyers barely change the quantity they buy when its price changes.
Exam-style practice questions
Practice questions written in the style of SEAB exam questions on this dot point, with worked answer explainers. The year tag is the paper they imitate, not the source.
Original4 marksThe price of a good rises from \10\ and the quantity demanded falls from units to units per week. Calculate the price elasticity of demand and state whether demand is elastic or inelastic.Show worked answer →
A 4 mark calculation rewards the correct method, the value, and the correct judgement.
- Percentage change in quantity demanded
- .
- Percentage change in price
- .
- PED
- .
The value, ignoring the minus sign, is , which is less than , so demand is price inelastic: quantity demanded changes by a smaller percentage than price.
Markers reward both percentage changes, the correct PED value, and the judgement that a value below means inelastic demand.
Original6 marksExplain three factors that determine whether the demand for a good is price elastic or price inelastic.Show worked answer →
A 6 mark question rewards three distinct factors, each explained with its effect on elasticity.
- Availability of substitutes
- If there are many close substitutes, a price rise sends buyers to alternatives, so demand is elastic. If there are few substitutes, demand is inelastic.
- Proportion of income spent
- If the good takes a large share of income (such as a car), a price change matters a lot, so demand tends to be elastic. If it takes a tiny share (such as salt), buyers barely notice, so demand is inelastic.
- Whether the good is a necessity or a luxury
- Necessities such as basic food have inelastic demand, because people must buy them whatever the price. Luxuries have more elastic demand, because they can be given up.
Markers reward three valid factors, each linked clearly to whether demand is elastic or inelastic, rather than just listed.
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