ECONOMICS · FREE QUIZ
Economics revision: elasticity
Level: A-level Economics and first-year university
Elasticity measures how much one variable responds to a change in another. It appears in almost every microeconomics paper, from A-level to first-year university. These notes cover the four elasticities you need, how they link to revenue and tax, and a worked example, followed by a free quiz.
Price elasticity of demand (PED)
PED = % change in quantity demanded ÷ % change in price. It is usually negative, so economists often talk about its size: above 1 is elastic, below 1 is inelastic, and exactly 1 is unitary.
- The number and closeness of substitutes
- The share of income spent on the good
- Whether it is a necessity or a luxury
- Habit or addiction
- Time: demand becomes more elastic in the long run
- How broadly the market is defined (food in general versus one brand of crisps)
PED and total revenue
- Inelastic demand: raising the price raises total revenue.
- Elastic demand: cutting the price raises total revenue.
- Unitary elasticity: total revenue does not change.
- Worked example: the price rises from £10 to £12, a 20% rise. Quantity demanded falls from 100 to 90, a 10% fall. PED = −10 ÷ 20 = −0.5, so demand is price inelastic, and total revenue rises from £1,000 to £1,080.
Income elasticity of demand (YED)
YED = % change in quantity demanded ÷ % change in income.
- Normal goods have a positive YED. Necessities are between 0 and 1; luxuries are above 1.
- Inferior goods have a negative YED: demand falls as incomes rise.
Cross elasticity of demand (XED)
XED = % change in quantity demanded of good A ÷ % change in price of good B. Substitutes have a positive XED, complements a negative XED, and unrelated goods an XED close to zero.
Price elasticity of supply (PES)
PES = % change in quantity supplied ÷ % change in price. It is positive. Supply is more elastic when firms have spare capacity or stocks, when production is quick, when factors of production are easy to switch, and over longer time periods.
Elasticity and tax
When the government adds an indirect tax, the burden falls more heavily on whichever side of the market is less elastic. With inelastic demand, as for tobacco or petrol, consumers pay most of the tax, and the government raises more revenue because sales fall only a little.
Test yourself
8 questions. Tap an answer to see whether you're right, and why.
Q1/8The price of a good rises by 10% and quantity demanded falls by 25%. What is the PED?
PED = −25 ÷ 10 = −2.5, so demand is price elastic.
Q2/8Demand for a good is price inelastic. If the firm raises its price, total revenue will:
Quantity falls by a smaller percentage than the price rises, so revenue goes up.
Q3/8Incomes rise by 5% and demand for a good falls by 2%. The good is:
YED = −2 ÷ 5 = −0.4. A negative YED means an inferior good.
Q4/8A good has a YED of +1.8. It is best described as:
A YED above 1 means demand grows faster than income: a luxury.
Q5/8The cross elasticity of demand between two complements, such as printers and ink cartridges, is:
If printers get more expensive, fewer are bought, so demand for ink falls.
Q6/8Which of these makes supply more price elastic?
Stocks let firms increase supply quickly when the price rises.
Q7/8An indirect tax is placed on a good with very price inelastic demand. Who bears most of the tax?
Firms can pass most of the tax on as higher prices because consumers keep buying.
Q8/8Why is demand for petrol price inelastic in the short run?
Drivers cannot quickly switch to other fuels or transport, so quantity responds little to price.
Questions
What is the formula for PED?
Percentage change in quantity demanded divided by percentage change in price.
Is PED always negative?
For almost all goods, yes, because price and quantity demanded move in opposite directions. Economists usually quote its size and ignore the sign.
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