What you'll learn

• Why a price change does not always lead to the same-sized change in quantity demanded.
• How to tell the difference between price elastic and price inelastic demand.
• How to calculate price elasticity of demand (PED) from given data.
• How producers, consumers and governments use PED in real UK markets.

3.1.3.5 Price elasticity of demand

Start with demand and quantity demanded

Before elasticity, you need two basic ideas.

Demand means the willingness and ability of consumers to buy a good or service at different prices.

Quantity demanded means the actual amount consumers want to buy at one particular price.

Usually, when price rises, quantity demanded falls. When price falls, quantity demanded rises. This is a movement along the demand curve, assuming other factors have not changed.

For example, if the price of a streaming subscription rises, some consumers may cancel and switch to another service. But if petrol prices rise, many commuters still need to drive to work, at least in the short run.

What price elasticity of demand means

Price elasticity of demand measures how responsive quantity demanded is to a change in price.

PED focuses on percentages, not just raw changes. This makes it easier to compare very different markets, such as a 20p rise in a Greggs snack and a £2,000 rise in the price of a used car.

Price elastic demand

Demand is price elastic when quantity demanded changes by a larger percentage than price.

In GCSE terms, demand is price elastic when the size of PED is above 1.

Example: if price rises by 10% and quantity demanded falls by 25%, consumers are very responsive.

Price inelastic demand

Demand is price inelastic when quantity demanded changes by a smaller percentage than price.

In GCSE terms, demand is price inelastic when the size of PED is below 1.

Example: if price rises by 10% and quantity demanded falls by only 3%, consumers are not very responsive.

The diagram below compares the same price rise for an inelastic good and an elastic good.

Measuring PED

To calculate PED, you need two percentage changes:

$$percentage\; change=\frac{new\; value-old\; value}{old\; value}\times 100$$

Then divide the percentage change in quantity demanded by the percentage change in price.

Why some goods have elastic or inelastic demand

PED depends on how easy it is for consumers to change their behaviour when price changes.

Availability of substitutes

A substitute is a good or service that can be used instead of another good or service.

If there are many close substitutes, demand tends to be more price elastic. For example, if one brand of crisps becomes more expensive, shoppers in Tesco can choose another brand.

If there are few substitutes, demand tends to be more price inelastic. For example, many households had limited alternatives when gas and electricity prices rose during the 2022–23 cost-of-living squeeze.

Necessity or luxury

A necessity is something consumers feel they need, such as basic food, heating or transport to work. Necessities tend to have more price inelastic demand.

A luxury is something consumers can more easily go without, such as premium holidays or expensive fashion items. Luxuries tend to have more price elastic demand.

Proportion of income spent

If a product takes up only a tiny proportion of income, consumers may not react much to a price rise. For example, a 10p rise in a small packet of chewing gum may not change many buying decisions.

If a product takes up a large proportion of income, consumers are more likely to compare prices and reduce demand. For example, a rise in rent or mortgage payments can strongly affect household choices.

Time period

Demand is often more inelastic in the short run because consumers need time to adjust.

Over time, demand can become more elastic. If petrol prices stay high, some consumers may switch to public transport, buy a more fuel-efficient car, cycle more, or move closer to work.

Brand loyalty and habit

If consumers are loyal to a brand, demand may be more inelastic. Some people will keep buying the same phone brand, trainers or coffee even after a price rise.

Habit-forming goods can also have inelastic demand, though this raises ethical issues if firms or governments rely on consumers struggling to cut consumption.

PED and total revenue

Total revenue is the money a producer receives from selling output.

PED matters because a price change affects both parts of total revenue: the price charged and the quantity sold.

If demand is price inelastic

A price rise may increase total revenue because quantity demanded falls by a smaller percentage than price rises.

This is why firms selling necessities may be tempted to raise prices. However, there are moral and ethical considerations, especially during a cost-of-living crisis. Raising prices for essential goods such as food, energy or medicines can put pressure on low-income households.

If demand is price elastic

A price rise may reduce total revenue because quantity demanded falls by a larger percentage than price rises.

For goods with elastic demand, firms may prefer discounts, loyalty schemes or sales promotions. A lower price can attract enough extra customers to increase revenue.

Implications for producers and consumers

Producers

Producers use PED when deciding whether to raise prices, cut prices, launch promotions or absorb higher costs.

For example, if a food producer faces higher energy and ingredient costs, it may pass some costs on to consumers. If demand is inelastic, sales may not fall much. If demand is elastic, customers may switch to supermarket own-brand alternatives.

PED also matters for taxes. The UK Soft Drinks Industry Levy, often called the sugar levy, increased costs for high-sugar drinks. If demand is elastic, higher prices may reduce consumption more. If demand is inelastic, consumers may keep buying, so the tax raises revenue but changes behaviour less.

Consumers

Consumers are affected differently depending on PED.

When demand is inelastic, consumers have fewer realistic choices. Price rises reduce their disposable income, especially for essentials such as rent, heating and transport.

When demand is elastic, consumers have more power to switch, delay buying, or choose cheaper alternatives. This can pressure firms to keep prices competitive.