Difficulty: Introductory to Intermediate | Prerequisites: Demand, Supply, and Market Equilibrium study notes (companion document).
Once you understand that the demand curve slopes downward, the natural next question is: by how much does quantity respond when price changes? That is what price elasticity of demand measures. It is one of the most tested concepts in introductory and intermediate microeconomics because it links the abstract demand curve to practical business and policy decisions, from setting prices to predicting tax revenue. You need to be comfortable with the demand curve, movements vs shifts, and basic percentage calculations before working through this material.
Price elasticity of demand tells you the percentage change in quantity demanded for a one-percent change in price. If quantity responds a lot, demand is elastic; if it barely budges, demand is inelastic. Whether demand is elastic or inelastic determines whether raising a price increases or decreases total revenue.
Price elasticity of demand (PED)
A measure of how sensitive quantity demanded is to a change in price, calculated as the percentage change in quantity demanded divided by the percentage change in price. Think of it as: "How much do buyers flinch when the price moves?"
Elastic demand
Demand where the absolute value of PED is greater than 1 (|PED| > 1). Quantity demanded responds more than proportionally to a price change. In simple terms, buyers are quite sensitive to price.
Inelastic demand
Demand where the absolute value of PED is less than 1 (|PED| < 1). Quantity demanded responds less than proportionally to a price change. In simple terms, buyers do not react much when price changes.
Unit elastic demand
Demand where |PED| equals exactly 1. The percentage change in quantity demanded is the same as the percentage change in price.
Total revenue (TR)
Price multiplied by quantity sold (TR = P x Q). The relationship between elasticity and total revenue is a key exam topic.
Slope of the demand curve
The absolute change in quantity for a given change in price (rise over run on the graph). Slope is constant along a linear demand curve, but elasticity is not.
Short-run elasticity
The responsiveness of quantity demanded (or supplied) to price in the immediate term, before consumers or producers have fully adjusted.
Long-run elasticity
The responsiveness after consumers and producers have had time to fully adjust their behaviour, typically larger than the short-run value.
Durable goods
Goods that provide services over many years (cars, appliances, furniture). Demand for durables tends to be more elastic in the short run because consumers can delay or accelerate purchases.
PED is calculated as: (% change in quantity demanded) / (% change in price).
The result is normally negative (because of the law of demand), but economists often refer to the absolute value when classifying demand as elastic or inelastic.
A high absolute value means buyers are very responsive to price. A low absolute value means they are not.
Slope measures the absolute change: "for each £1 price increase, quantity falls by X units." Slope is constant along a straight-line demand curve.
Elasticity measures the relative (percentage) change. Even on a linear demand curve with a constant slope, elasticity varies from point to point.
This distinction trips up many students. A steep curve does not automatically mean inelastic demand, and a flat curve does not automatically mean elastic demand, because elasticity also depends on where you are on the curve.
Elastic demand (|PED| > 1): quantity responds more than proportionally. A 10% price increase causes more than a 10% drop in quantity demanded.
Inelastic demand (|PED| < 1): quantity responds less than proportionally. A 10% price increase causes less than a 10% drop in quantity demanded.
Unit elastic demand (|PED| = 1): quantity responds exactly proportionally.
At the top of the curve (high price, low quantity): demand is elastic.
At the bottom of the curve (low price, high quantity): demand is inelastic.
At the exact midpoint: demand is unit elastic.
This matters because the same straight-line demand curve contains all three types of elasticity at different points along it.
Total revenue = P x Q.
Elastic demand: a price increase causes a proportionally larger fall in quantity, so total revenue decreases. Lowering price increases total revenue.
Inelastic demand: a price increase causes a proportionally smaller fall in quantity, so total revenue increases. Lowering price decreases total revenue.
Unit elastic demand: total revenue is at its maximum and does not change with small price adjustments.
This is the key insight for business pricing: whether raising or lowering your price will bring in more money depends entirely on the elasticity of demand for your product.
Availability of substitutes: the more close substitutes a good has, the more elastic the demand, because consumers can switch easily.
Necessities vs luxuries: necessities (medicine, basic food) tend to have inelastic demand; luxuries tend to have elastic demand.
Proportion of income: goods that take up a large share of a consumer's budget tend to have more elastic demand, because a price change has a bigger impact.
Time horizon: demand tends to be more elastic in the long run, as consumers have more time to find alternatives and adjust their habits.
Short-run elasticity captures the immediate response. For non-durable goods (food, petrol), demand tends to be relatively inelastic in the short run because consumption is hard to adjust quickly.
Long-run elasticity captures the response once consumers have fully adjusted. It is generally higher for both demand and supply.
Durable goods (cars, washing machines) show a different pattern. Demand for durables is more elastic in the short run, because consumers can bring forward or delay a purchase.
Non-durables show the opposite: less elastic in the short run, more elastic in the long run.
Economists estimate elasticities by observing how shifts in demand or supply affect equilibrium prices and quantities.
The method involves holding one curve constant, observing the magnitude of a shift in the other, and using the price and quantity changes to calculate the implied elasticity.
Price Elasticity of Demand
PED = (% change in Qd) / (% change in P)
Alternatively, using the point elasticity formula: PED = (dQ/dP) x (P/Q)
Total Revenue
TR = P x Q
Relationship summary
|PED| > 1 (elastic): price up, TR down.
|PED| < 1 (inelastic): price up, TR up.
|PED| = 1 (unit elastic): TR is maximised; small price changes leave it unchanged.
Linear demand curve diagram
On a standard linear demand curve, the top half (above the midpoint) is the elastic region, the bottom half is the inelastic region, and the midpoint itself is the unit elastic point. Total revenue is maximised at the midpoint quantity.
Elasticity explains why governments tax cigarettes and petrol rather than luxury handbags when they want reliable revenue: demand for cigarettes and petrol is inelastic, so the tax does not drastically cut sales. It also explains why airlines charge wildly different prices for the same seat: business travellers have inelastic demand (they need to fly), while leisure travellers have elastic demand (they can choose not to go or drive instead).
Students often assume that a steeper demand curve means more inelastic demand. Slope and elasticity are different measures. A steep curve can be elastic at certain points, and elasticity changes along any linear demand curve even though the slope does not.
Many students forget that PED is normally negative (price up, quantity down) and get confused about the sign. The convention is to discuss the absolute value when classifying demand as elastic, inelastic, or unit elastic.
A frequent exam mistake is claiming that raising the price always increases revenue. That is only true when demand is inelastic. When demand is elastic, raising the price reduces total revenue.
Students sometimes treat "elastic" and "inelastic" as fixed labels for a good. In reality, the same good can have different elasticities depending on the price range, the time horizon, and the availability of substitutes in a given market.
⚠️ The elasticity-and-total-revenue relationship is tested constantly. Know the three cases cold: elastic (price up = TR down), inelastic (price up = TR up), unit elastic (TR maximised).
⚠️ Expect questions asking you to calculate PED from given data and then classify demand. Watch the sign and use the absolute value for classification.
⚠️ Diagram questions may ask you to identify the elastic, inelastic, and unit elastic regions on a linear demand curve. The midpoint is the dividing line.
⚠️ Be ready to explain why elasticity varies along a linear demand curve even though slope is constant. This is a favourite conceptual question.
Q: True or false: Elasticity and slope measure the same thing.
A: False. Slope measures the absolute change in quantity per unit change in price. Elasticity measures the percentage change.
Q: Fill in the blank: If |PED| = 0.4, demand is ______, and raising the price will ______ total revenue.
A: Inelastic; increase.
Q: True or false: On a linear demand curve, demand is equally elastic at every point.
A: False. Elasticity varies: elastic at the top, unit elastic at the midpoint, inelastic at the bottom.
Q: True or false: Demand for necessities tends to be more elastic than demand for luxuries.
A: False. Necessities tend to be inelastic; luxuries tend to be elastic.
Q: Fill in the blank: Demand becomes more elastic over longer time horizons because consumers have more time to ______.
A: Find alternatives and adjust their behaviour.
Q: The price of a gym membership rises by 15%, and the number of members falls by 5%. Calculate the price elasticity of demand and classify it.
A: PED = -5% / 15% = -0.33. |PED| = 0.33, which is less than 1, so demand is inelastic.
Q: A firm is considering raising the price of its product. Demand is currently elastic. Should it raise the price if its goal is to maximise total revenue? Explain.
A: No. When demand is elastic, a price increase causes a proportionally larger decrease in quantity demanded, so total revenue falls. To increase total revenue with elastic demand, the firm should lower the price.
Q: Explain why the demand for insulin is likely to be highly inelastic.
A: Insulin is a necessity with no close substitutes for people who need it, and it takes up a relatively small share of most users' overall spending. These three factors (necessity, lack of substitutes, small budget share) all push elasticity toward inelastic.
Q: Why does elasticity vary along a linear demand curve even though slope is constant?
A: Elasticity is a ratio of percentage changes, not absolute changes. At the top of the curve (high price, low quantity), a small absolute change in quantity represents a large percentage change in quantity but a small percentage change in price, making demand elastic. At the bottom (low price, high quantity), the reverse is true.
Q: Explain why demand for cars is more elastic in the short run than demand for petrol.
A: Cars are durable goods, so consumers can delay or bring forward a purchase in response to price changes. Petrol is a non-durable necessity consumed regularly, and consumers cannot easily reduce consumption in the short run.
Elasticity builds directly on the demand curve mechanics from the companion study notes (Demand, Supply, and Market Equilibrium). It connects forward to tax incidence analysis, where the relative elasticities of demand and supply determine who bears the burden of a tax.
The total-revenue relationship resurfaces in monopoly pricing, where a profit-maximising monopolist always operates in the elastic portion of its demand curve. Elasticity also matters for welfare analysis: the deadweight loss from a tax is larger when both demand and supply are more elastic.
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