Elasticities of demand: the core idea

· Elasticity measures how responsive quantity demanded is to a change in another variable.
· In this subtopic, focus on Price Elasticity of Demand (PED) and Income Elasticity of Demand (YED).
· In exams, always link elasticity to consumer responsiveness, steepness/flatness of curves, revenue effects, and real-world business/government decisions.
· A key idea: the larger the response, the more elastic demand is; the smaller the response, the more inelastic demand is.

Price elasticity of demand (PED)

· PED = percentage change in quantity demanded ÷ percentage change in price.
· Formula: PED = \frac{%\Delta Q_d}{%\Delta P}
· Because price and quantity demanded usually move in opposite directions, PED is usually negative. In IB, it is common to discuss the magnitude of PED and ignore the minus sign in written analysis.
· PED shows how strongly consumers react to price changes.
· Use PED when explaining whether a price rise or price fall causes a small or large change in quantity demanded.

This diagram shows a demand curve used to illustrate price elasticity of demand. It helps students see that PED compares the percentage change in quantity demanded with the percentage change in price. Use it to practise reading changes in price and quantity directly from a graph. Source

Degrees of PED

· Perfectly elastic demand: PED = ∞; consumers buy at one price only; demand curve is horizontal.
· Relatively elastic demand: PED > 1; quantity demanded changes by a larger percentage than price.
· Unit elastic demand: PED = 1; quantity demanded changes by the same percentage as price.
· Relatively inelastic demand: PED < 1; quantity demanded changes by a smaller percentage than price.
· Perfectly inelastic demand: PED = 0; quantity demanded does not change when price changes; demand curve is vertical.
· Exam shortcut: flatter demand = more elastic, steeper demand = more inelastic.

This image shows how elasticity changes along a straight-line downward-sloping demand curve. The upper section is more elastic, the midpoint is unit elastic, and the lower section is more inelastic. This is especially useful for HL students and for linking PED to total revenue. Source

Determinants of PED

· Number and closeness of substitutes: more and closer substitutes → more elastic demand.
· Degree of necessity: necessities tend to have inelastic demand; luxuries tend to have elastic demand.
· Proportion of income spent on the good: if the good takes a large share of income, demand is usually more elastic.
· Time: demand is usually more elastic in the long run because consumers have more time to adjust behaviour.
· Strong exam answers apply these determinants to a specific good, not just define them abstractly.

PED and total revenue

· Total revenue (TR) = price × quantity sold.
· Formula: $TR = P \times Q$
· If demand is elastic (PED > 1): a price fall increases TR, and a price rise decreases TR.
· If demand is inelastic (PED < 1): a price rise increases TR, and a price fall decreases TR.
· If demand is unit elastic (PED = 1): a change in price leaves TR unchanged.
· This relationship is a favourite exam application for firms deciding whether to raise or lower price.

This diagram shows the relationship between PED and total revenue on a straight-line demand curve. Revenue rises as price falls in the elastic range, is maximised at unit elasticity, and falls as price falls in the inelastic range. It is ideal for exam questions about pricing decisions. Source

Why PED matters

· For firms: helps with pricing strategy, revenue forecasting, and decisions about whether a price change is likely to increase or decrease sales revenue.
· For governments: helps predict the effect of indirect taxes, subsidy removal, or policies affecting prices.
· Goods with inelastic demand are often better targets for revenue-raising taxes because quantity demanded falls by relatively little.
· PED also helps explain why some producers face large revenue swings when prices change.

Income elasticity of demand (YED)

· YED measures responsiveness of quantity demanded to a change in income.
· Formula: YED = \frac{%\Delta Q_d}{%\Delta Y}
· YED tells us whether a good is normal or inferior, and whether it is a necessity or luxury/service-type good.
· The sign of YED is essential in exam answers.

This diagram shows Engel curves for different values of income elasticity of demand. It helps distinguish luxury, normal, zero-elasticity, and inferior goods by how demand changes as income rises. Use it to connect YED signs and magnitudes to curve shapes. Source

Interpreting YED

· Positive YED → normal good: demand rises as income rises.
· Negative YED → inferior good: demand falls as income rises.
· YED > 1 → income elastic demand: typically luxury goods and many services.
· 0 < YED < 1 → income inelastic demand: typically necessities.
· YED = 0 → demand is unaffected by income changes.
· Always interpret both the sign and the size of YED.

This diagram shows an inferior good, where quantity demanded falls as income rises beyond a certain point. It is useful for remembering that negative YED means consumers switch away from the good when they become richer. Use it when revising the difference between normal and inferior goods. Source

Importance of YED

· For firms: helps predict how demand will change when consumer incomes rise or fall.
· Firms selling luxury goods benefit more from economic growth, but are more vulnerable in recessions.
· Firms selling necessities usually face more stable demand when incomes change.
· YED helps explain changing spending patterns as economies develop.

Common exam skills and traps

· Do not confuse slope with elasticity: a straight line has constant slope, but changing PED along the curve.
· Do not forget the sign of YED: positive = normal, negative = inferior.
· For PED, examiners usually reward discussion of the magnitude, not just writing a negative number.
· When asked about revenue, explicitly state whether demand is elastic, inelastic, or unit elastic before judging the effect of a price change.
· In data questions, show the formula, substitute the numbers carefully, and then interpret the result in words.