# Price Elasticity of Demand (PED)

> CIE IGCSE Economics · 0455 2023-2026
> Source: https://www.owlsprep.com/study/cie-0455-u2-price-elasticity-of-demand/

This guide covers all CIE IGCSE 0455 content for Price Elasticity of Demand (PED), including formula, calculations, value classification, determinants, links to total revenue, and exam-style structured question applications.

**Prerequisites:** [Understanding of the downward-sloping demand curve](https://www.owlsprep.com/study/cie-0455-u2-demand-supply/); Ability to calculate percentage change

## Learning objectives

- Define Price Elasticity of Demand (PED) and its standard formula
- Calculate PED from given price and quantity demanded data
- Interpret PED values to classify demand as elastic, inelastic, unit elastic, perfectly elastic or perfectly inelastic
- Explain the relationship between PED and total revenue for producers
- Identify the 5 key factors that influence the PED of a good or service
- Apply PED concepts to real-world business and government policy scenarios for structured exam questions

## Definition and Formula for PED

**Price Elasticity of Demand (PED)** — A unit-free measure of how much quantity demanded of a good changes when its own price changes, holding all other factors constant.

*Notation:* PED

PED is calculated as the ratio of the percentage change in quantity demanded to the percentage change in price, as shown below:

$$PED = \frac{\% \Delta Q_d}{\% \Delta P}$$

Where $\% \Delta Q_d = \frac{New \ Q_d - Old \ Q_d}{Old \ Q_d} \times 100$ and $\% \Delta P = \frac{New \ P - Old \ P}{Old \ P} \times 100$.

**Worked example:** The price of a loaf of bread rises from \$1.00 to \$1.20, and weekly quantity demanded falls from 200 loaves to 180 loaves. Calculate PED for bread.

1. Calculate percentage change in price: $\frac{1.20 - 1.00}{1.00} \times 100 = 20\%$
2. Calculate percentage change in quantity demanded: $\frac{180 - 200}{200} \times 100 = -10\%$
3. Substitute into PED formula: $PED = \frac{-10}{20} = -0.5$
4. Absolute value for classification: 0.5

> **Exam tip:** Always show full calculation steps for PED questions: marks are awarded for working even if your final answer is slightly incorrect.

*Calculator:* allowed

## Interpreting PED Values

We ignore the negative sign of PED when classifying elasticity, as it only reflects the inverse relationship between price and quantity demanded. The 5 standard classifications are listed below:

| Absolute PED Value | Classification | Description |
| --- | --- | --- |
| 0 | Perfectly Inelastic | Quantity demanded does not change at all when price changes |
| < 1 | Relatively Inelastic | % change in Qd is smaller than % change in price |
| 1 | Unit Elastic | % change in Qd exactly equals % change in price |
| > 1 | Relatively Elastic | % change in Qd is larger than % change in price |
| ∞ | Perfectly Elastic | Any price increase causes quantity demanded to fall to 0 |

**Worked example:** Classify each PED value below: a) 3.2 b) 0.7 c) 1 d) 0

1. a) 3.2 > 1 → Relatively elastic demand
2. b) 0.7 < 1 → Relatively inelastic demand
3. c) 1 → Unit elastic demand
4. d) 0 → Perfectly inelastic demand

> **Exam tip:** If an exam question asks if demand is elastic or inelastic, always explicitly compare your calculated PED to 1 after taking its absolute value to earn full marks.

## PED and Total Revenue

Total revenue (TR) for a firm is calculated as $TR = Price \times Quantity \ Sold$. The effect of a price change on total revenue depends entirely on the PED of the good:

- If demand is **inelastic (PED <1)**: Price rise → TR rises; Price fall → TR falls
- If demand is **elastic (PED >1)**: Price rise → TR falls; Price fall → TR rises
- If demand is **unit elastic (PED =1)**: Any price change leaves total revenue unchanged

**Worked example:** A café sells 300 lattes per week at \$4 each, with a PED of 1.5 for lattes. If the café cuts price to \$3.60, calculate the new total revenue and comment on whether the price cut was a good business decision.

1. Current total revenue: $300 \times 4 = \$1200$
2. % change in price: $\frac{3.60 - 4}{4} \times 100 = -10\%$
3. Rearrange PED formula to find % change in Qd: $\% \Delta Q_d = PED \times \% \Delta P = 1.5 \times 10 = +15\%$
4. New quantity demanded: $300 \times 1.15 = 345$ lattes per week
5. New total revenue: $345 \times 3.60 = \$1242$
6. Comment: Total revenue increased by \$42, so the price cut was a good decision as demand for lattes is elastic.

> **Exam tip:** You may be asked to link PED to a linear demand curve: the upper half of a straight-line demand curve is elastic, the midpoint is unit elastic, and the lower half is inelastic.

*Calculator:* allowed

## Factors Affecting PED

There are 5 key determinants of PED that you need to memorise for the exam:

- **Availability of close substitutes**: More substitutes → more elastic demand, as consumers can easily switch alternatives if price rises
- **Degree of necessity**: Necessities (e.g. food, medicine) have inelastic demand; luxuries have elastic demand
- **Proportion of income spent on the good**: Goods that take up a small share of income (e.g. matches) have inelastic demand; expensive goods have more elastic demand
- **Time period**: Demand is more elastic over longer time periods, as consumers have time to adjust their spending habits
- **Habit formation**: Habitual goods (e.g. cigarettes) have inelastic demand, as consumers are less responsive to price changes

**Worked example:** Explain why demand for prescription insulin is likely to be price inelastic.

1. Insulin is a life-saving necessity for people with diabetes, with no close substitutes available.
2. Even if the price of insulin rises significantly, patients will still purchase almost the same quantity to manage their condition.
3. This means the percentage change in quantity demanded is far smaller than the percentage change in price, so PED < 1, making demand inelastic.

## Real-World Applications of PED

PED is used by both businesses and governments to make decisions:

- **Firms**: Use PED to set prices to maximise total revenue, e.g. cinemas cut ticket prices for off-peak screenings where demand is elastic to raise revenue
- **Governments**: Use PED to predict the effect of indirect taxes on consumption and tax revenue, e.g. taxes on inelastic goods like cigarettes raise large tax revenue even if they have a small effect on consumption

**Worked example:** A government imposes a tax on cigarettes to reduce smoking rates. If PED for cigarettes is 0.3, explain whether the tax will be effective at reducing smoking, and whether it will raise significant tax revenue.

1. PED = 0.3 < 1, so demand for cigarettes is relatively inelastic.
2. Effect on smoking: The tax will raise cigarette prices, but the percentage fall in quantity demanded will be much smaller than the percentage rise in price, so the tax will have limited effectiveness at reducing smoking rates.
3. Effect on tax revenue: Since consumption of cigarettes falls very little after the tax, the government will earn a large amount of tax revenue from each pack sold, making the tax a good source of government income.

> **Exam tip:** When answering application questions, always explicitly reference the PED value or classification in your explanation to earn full marks.

## Common pitfalls

- **Wrong:** Keeping the negative sign when classifying PED, leading you to incorrectly state that a PED of -2 is less than 1 and therefore inelastic.
  - Why it fails: The negative sign only reflects the inverse relationship between price and quantity demanded, not the size of the responsiveness.
  - Correct: Always take the absolute value of PED before comparing it to 1 to classify elasticity.
- **Wrong:** Mixing up the PED formula by putting percentage change in price as the numerator.
  - Why it fails: This reverses the calculated value, leading to incorrect elasticity classification.
  - Correct: Remember that PED measures the response of quantity demanded to price changes: quantity change is always the numerator.
- **Wrong:** Stating that necessities have perfectly inelastic demand.
  - Why it fails: Even necessities have some price responsiveness: for example, consumers may cut back on food waste if food prices rise, so PED is usually less than 1 but not zero.
  - Correct: Clarify that necessities have *relatively* inelastic demand, not perfectly inelastic, unless explicitly stated.
- **Wrong:** Assuming a price rise always increases total revenue.
  - Why it fails: This is only true if demand is inelastic: if demand is elastic, a price rise will reduce total revenue.
  - Correct: First identify the PED classification of the good, then apply the PED-total revenue rule to predict the effect of a price change.
- **Wrong:** Calculating percentage change using the new value as the denominator instead of the original value.
  - Why it fails: This produces an incorrect percentage change, leading to a wrong PED calculation.
  - Correct: Use the formula $\% \Delta = \frac{New - Old}{Old} \times 100$ for both price and quantity changes.

## Cheatsheet

| Concept | Key Exam Reference |
| --- | --- |
| PED Formula | $\frac{\% \Delta Q_d}{\% \Delta P}$, drop negative sign for classification |
| Inelastic Demand | PED <1: Price rise → Total revenue rises |
| Elastic Demand | PED >1: Price rise → Total revenue falls |
| Unit Elastic | PED =1: Price change leaves total revenue unchanged |
| PED Determinants | Substitutes, necessity, income share, time, habit formation |

## What's next

Now that you have mastered Price Elasticity of Demand for CIE IGCSE Economics 0455, you can apply this knowledge to related microeconomic topics in Unit 2: The Allocation of Resources. Next, you will explore how PED interacts with government interventions like indirect taxes and price controls to determine market outcomes, a common topic for 6-mark structured questions in Paper 2. You will also use PED to analyse real-world case studies, such as the impact of fuel taxes or minimum alcohol pricing, that appear frequently on past exams. Make sure to practice full structured PED questions to build your answer-writing skills for the exam.

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