Price Elasticity of Demand
Understand how responsive demand is to price changes — and why this matters for business decisions
Key Concepts at a Glance
- PED measures how quantity demanded responds to price changes
- Calculate using % change in QD ÷ % change in price
- Interpret values from 0 (inelastic) to ∞ (elastic)
- SPLAT determines elasticity: substitutes, price, luxury, addictive, time
- Revenue rule: Raise price on inelastic, lower on elastic goods
- Applies to firm strategy and government taxation/subsidies
What is Price Elasticity of Demand?
Imagine two shops on the same street. One sells luxury watches; the other sells bread. When the watch shop raises prices by 20%, hardly any customers leave — they still want that exclusive model. When the bakery raises bread prices by just 5%, half the customers switch to the supermarket. Why? Because demand responds differently to price depending on what the product is.
Price elasticity of demand (PED) is a measure that tells us exactly how much quantity demanded changes when price changes. It answers: "Are consumers sensitive to price changes for this product?"
Core Definition: PED reveals the responsiveness (or "elasticity") of quantity demanded to a change in price. A highly responsive demand is elastic; an unresponsive demand is inelastic.
Why Does This Matter?
If you run a business, knowing your product's PED is crucial because it tells you whether to raise or lower prices to earn more money. Raise prices on a watch (inelastic) and revenue goes up. Raise prices on bread (elastic) and revenue crashes. Get it wrong, and you lose thousands.
Calculating Price Elasticity of Demand
The Formula
Before you use this formula, you need to calculate the percentage changes. Use this formula for each:
The key is: always divide by the OLD value, not the new one. This is a very common mistake.
Worked Example
A firm raises prices and wants to know the elasticity
Given Information
Price rises from £10 to £15
Sales fall from 100 units to 40 units per day
Calculate PED and interpret the result.
Step 1: Calculate % change in Quantity Demanded
% Δ QD = (40 − 100) / 100 × 100
% Δ QD = −60 / 100 × 100
% Δ QD = −60%
Interpretation: Quantity demanded fell by 60% when price increased.
Step 2: Calculate % change in Price
% Δ P = (15 − 10) / 10 × 100
% Δ P = 5 / 10 × 100
% Δ P = 50%
Interpretation: Price increased by 50%.
Step 3: Apply the PED formula
PED = −60% / 50%
PED = −1.2
Important: PED is always negative (because of the law of demand — when price rises, quantity falls). Economists ignore the negative sign and write the answer as
1.2.
Step 4: Interpret
elastic demand
wrong decision
Practice Question 1
A cinema lowers ticket prices from £12 to £10 (a 16.7% decrease). Attendance rises from 500 to 650 people per showing. Calculate the PED for cinema tickets.