Price Elasticity of Demand Explained - IGCSE / O-Level Economics (PED Formula, Elastic vs Inelastic)
You already know that when the price of something goes up, people buy less of it. But by how much less? That single question is worth a surprising number of marks in IGCSE and O-Level Economics, and the tool that answers it is price elasticity of demand. This guide covers everything you need for the exam — the formula, how to read the answer, what makes demand elastic or inelastic, and the all-important link to a firm's revenue.
Why the Law of Demand isn't enough
The Law of Demand tells us that, ceteris paribus, a rise in price causes a fall in quantity demanded. That's the direction of the change. What it doesn't tell us is the size — and the size is what matters to a business deciding whether to raise its prices, or to a government deciding what to tax.
What is price elasticity of demand?
Price elasticity of demand (PED) measures how responsive the quantity demanded of a good is to a change in that good's own price. Picture an elastic band: some goods stretch a long way when price moves, others barely move at all.
The formula
PED = % change in quantity demanded ÷ % change in price
And remember how to find a percentage change:
% change = (change ÷ original value) × 100
Why your answer will be negative
Because price and quantity demanded move in opposite directions, PED is normally a negative number. This is expected — write the minus sign down, but when classifying the answer we compare the size of the number (its modulus, written |PED|) and ignore the sign.
⚠️ This is the classic marking trap. A PED of −1.5 is elastic, even though −1.5 is mathematically less than 1. Always compare |PED| to 1, never the raw negative value.
Worked example 1 — a coffee shop
A coffee shop raises its price from $10 to $12. Sales fall from 100 cups to 70.
- % change in price = (2 ÷ 10) × 100 = +20%
- % change in quantity = (−30 ÷ 100) × 100 = −30%
- PED = −30 ÷ 20 = −1.5
We'll come back to what this did to the shop's revenue.
How to read the number
Everything hinges on comparing |PED| — the size, ignoring the minus sign — to 1:
| |PED| | Name | What it means |
|---|---|---|
| Greater than 1 | Elastic | Quantity changes proportionally more than price |
| Less than 1 | Inelastic | Quantity changes proportionally less than price |
| Exactly 1 | Unit elastic | The two changes match exactly |
| 0 | Perfectly inelastic | Quantity doesn't change at all (vertical curve) |
| Infinite | Perfectly elastic | Any price rise wipes out demand (horizontal curve) |
Our coffee shop, at |−1.5| = 1.5, has elastic demand.
Elastic demand
When |PED| is greater than 1, the demand curve is shallow. Buyers are sensitive to price because they have alternatives — branded soft drinks, restaurant meals, foreign holidays.
Inelastic demand
When |PED| is less than 1, the demand curve is steep. Buyers keep purchasing even as price climbs — petrol, prescription medicine, salt, bread.
What determines PED? Remember SPLAT
- Substitutes available — more substitutes make demand more elastic
- Proportion of income spent — the bigger the share of your budget, the more elastic
- Luxury or necessity — luxuries are elastic, necessities inelastic
- Addictiveness or habit — habit-forming goods are inelastic
- Time period — demand is more elastic in the long run, once buyers can adjust
Reverse each one and you get the inelastic case. Quoting SPLAT and then applying it to the good in the question is what separates a top answer from an average one. (SPLAT is a memory aid, not syllabus wording — make sure you can name the five determinants without it.)
PED and total revenue — the big application
Total revenue = price × quantity.
When a firm raises its price, revenue gets pulled in two directions: up by the higher price per unit, and down by the units it no longer sells. PED decides which pull wins.
If demand is ELASTIC (|PED| > 1) → raise price, revenue falls · cut price, revenue rises
If demand is INELASTIC (|PED| < 1) → raise price, revenue rises · cut price, revenue falls
If demand is UNIT ELASTIC (|PED| = 1) → revenue is unchanged
Back to worked example 1 — the elastic case
Our coffee shop was elastic at −1.5, and it raised its price. The rule says revenue should fall:
- Revenue before = 100 × $10 = $1,000
- Revenue after = 70 × $12 = $840
Revenue falls by $160. The shop charged more per cup and ended up worse off — the counter-intuitive result that elastic demand produces, and a favourite exam scenario.
Worked example 2 — petrol, the inelastic case
A petrol station raises its price from £1.00 to £1.10 (+10%). Sales fall from 500 to 490 litres (−2%).
- PED = −2 ÷ 10 = −0.2 → |PED| < 1, inelastic
- Revenue before = 500 × £1.00 = £500
- Revenue after = 490 × £1.10 = £539
Revenue rises — exactly what the rule predicts for an inelastic good facing a price increase. Same direction of price change, opposite revenue outcome, purely because of elasticity.
Inelastic demand is also part of why governments tax goods such as fuel, alcohol and tobacco: because demand barely falls, the tax raises reliable revenue. But note for the exam that revenue is only one motive — these are also demerit goods with negative externalities, and taxing them is meant to discourage consumption and make the polluter or consumer bear the external cost. A strong answer gives both reasons.
Key exam terms
Price elasticity of demand · Elastic · Inelastic · Unit elastic · Perfectly elastic · Perfectly inelastic · Total revenue · Substitutes · Ceteris paribus.
Quick recap
- PED = %ΔQ ÷ %ΔP — and the answer is normally negative.
- Compare |PED| to 1 — above 1 is elastic, below 1 is inelastic. Never compare the raw negative number.
- Elastic → price and revenue move in opposite directions. Inelastic → they move together.
Master those three and elasticity questions become some of the most reliable marks on the paper.
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