Elasticity of demand

A flatter demand curve indicates more elastic demand (small price change → big Qd change). A steeper demand curve indicates more inelastic demand (big price change → small Qd change).

1) Number and closeness of substitutes. 2) Necessity vs luxury. 3) Proportion of income spent. 4) Time. 5) Habit/addiction.

A measure of the responsiveness of quantity demanded to a change in the price of a good. PED = % change in quantity demanded ÷ % change in price.

If a good has many close substitutes, a price increase causes consumers to switch easily to alternatives. The more options available, the more responsive (elastic) demand is. Butter (many alternatives) is elastic; insulin (no substitute) is inelastic.

Because of the law of demand — when price rises, quantity demanded falls (and vice versa). A positive change in price produces a negative change in Qd, making the ratio negative. In the IB we often use the absolute value.

A vertical straight line. PED = 0. No matter how much price changes, quantity demanded stays the same. Example: a life-saving drug with no alternative — consumers must buy the same quantity regardless of price.

Necessities are needed regardless of price (e.g. medicine, basic food) so quantity demanded barely changes. Luxuries can be postponed or abandoned when price rises. Consumers can "live without" luxuries but not necessities.

A horizontal straight line. PED = ∞. At the market price, consumers will buy any quantity. Any price increase causes quantity demanded to fall to zero. Example: a small firm in a perfectly competitive market.

Demand is elastic — quantity demanded changes by a larger percentage than price. Consumers are sensitive to price changes. Example: if price rises 10% and Qd falls 20%, PED = −2 (elastic).

Demand is more elastic over time because consumers have more opportunity to find alternatives, change habits, or switch products. In the short run, they may be "stuck" with their current choice. In the long run, they adjust.

No. Elasticity changes along a straight-line demand curve. At the top (high P, low Q) demand is elastic. At the bottom (low P, high Q) it is inelastic. The midpoint is unit elastic. This is a common exam trap.

Demand is inelastic — quantity demanded changes by a smaller percentage than price. Consumers are insensitive to price changes. They keep buying despite the price rise.

|PED| > 1 = elastic. |PED| < 1 = inelastic. |PED| = 1 = unit elastic (Qd changes exactly same % as P). |PED| = 0 = perfectly inelastic (vertical D, Qd fixed). |PED| = ∞ = perfectly elastic (horizontal D).

For elastic demand: draw a relatively flat (shallow) curve. For inelastic demand: draw a relatively steep curve. Always label the curve clearly (e.g. D_elastic or D_inelastic) so the examiner knows which you intend.

Do NOT just state "demand is inelastic." Use the determinants to explain WHY: "Demand for insulin is inelastic because there are no substitutes and it is a medical necessity." Always link PED to a specific determinant with a real example.

Firms estimate PED for their products and set prices accordingly. Elastic demand → competitive pricing, discounts, promotions. Inelastic demand → premium pricing. They also use price discrimination — charging different prices to groups with different PED.

Total revenue = P × Q. Elastic demand (|PED|>1): lower price → TR rises because Qd increase outweighs the price cut. Inelastic demand (|PED|<1): raise price → TR rises because Qd barely falls. Unit elastic: TR unchanged.

Total revenue is the rectangle formed by P × Q. The width is Qₑ (along the X-axis) and the height is Pₑ (up the Y-axis). The area of this rectangle equals total revenue.

Draw the original P₁ × Q₁ rectangle (shaded one colour). Draw the new P₂ × Q₂ rectangle (shaded another colour). Compare the areas: if the new rectangle is bigger → TR increased. If smaller → TR decreased.

Lower its price. With elastic demand (|PED|>1), the percentage increase in Qd is larger than the percentage fall in price, so P × Q (total revenue) rises. Raising the price would cause TR to fall because too many customers are lost.

Sales lower the price. For products with elastic demand, the percentage increase in Qd exceeds the percentage price cut, so total revenue rises. For inelastic products, cutting the price lowers revenue because few extra sales are generated.

The rectangle gets BIGGER. Price falls (height shrinks) but quantity rises by a larger proportion (width expands a lot). The gain in width exceeds the loss in height, so the area (TR) increases. Use this visual check to confirm your reasoning.

Taxing inelastic goods (cigarettes, petrol) generates more revenue because consumers keep buying despite higher prices. The tax raises the price but quantity demanded barely falls, so tax revenue (tax × Q) is high.

Raise its price. With inelastic demand (|PED|<1), quantity demanded barely falls, so the higher price generates more TR per unit sold. The small loss in sales volume is more than offset by the higher price per unit.

Because inelastic demand means consumers barely reduce their quantity purchased even when price rises. Cigarette taxes raise lots of revenue but do not dramatically cut smoking because demand is inelastic (addiction). This is a common exam evaluation point.

Popcorn has inelastic demand inside the cinema (no alternatives available), so raising its price increases revenue. Movie tickets have elastic demand (many entertainment alternatives), so discounts attract more customers and increase ticket revenue.

The rectangle gets BIGGER. Price rises (height grows) and quantity barely falls (width shrinks only slightly). The gain in height more than offsets the small loss in width, so area (TR) increases.

With elastic demand, go LOW on price to maximise revenue. With inelastic demand, go HIGH on price. This is because elastic demand means customers are very responsive to price, so higher prices lose too many sales.

With inelastic demand, producers can pass more of the tax on to consumers (consumers keep buying). With elastic demand, producers must absorb more of the tax themselves because consumers would switch away if the price rose too much.

It provides a quick visual cross-check of your PED–revenue analysis. If you calculated that TR should rise but the new rectangle looks smaller, you made an error. It also earns diagram marks in data response questions.

YED = % change in quantity demanded ÷ % change in income. It measures how demand responds to income changes. Unlike PED, the sign of YED matters — it tells you the type of good.

Luxury firms (high YED) benefit during booms but suffer in recessions. Necessity firms (low YED) have stable demand in both. Firms with high YED may diversify into necessities for stability. Understanding YED helps firms plan inventory and investment.

XED = % change in quantity demanded of Good A ÷ % change in price of Good B. It measures the relationship between two goods — whether they are substitutes, complements, or unrelated.

The goods are substitutes. When the price of Good B rises, demand for Good A increases (consumers switch). Example: price of PlayStation rises → demand for Xbox rises. The larger the positive value, the closer the substitutes.

As national income grows, demand shifts from inferior goods (cheap staples) to normal goods (processed food, electronics) and then to luxuries. Countries experience structural changes in consumption as YED drives demand patterns.

A normal good — demand rises as income rises. If YED > 1, the good is a luxury (demand rises more than income, e.g. designer clothes). If 0 < YED < 1, the good is a necessity (demand rises less than income, e.g. bread).

A high positive XED means a competitor's price change will significantly affect your sales (close substitutes = price war risk). Firms with high XED between their products and rivals' must match price cuts or differentiate to reduce substitutability.

An inferior good — demand falls as income rises. Consumers switch away from inferior goods (e.g. instant noodles, budget airlines) towards higher-quality alternatives when they can afford to.

The goods are complements (used together). When the price of Good B rises, demand for Good A falls because consumers buy less of both. Example: price of printers rises → demand for ink falls.

YED > 1 → luxury (normal good). 0 < YED < 1 → necessity (normal good). YED < 0 → inferior good. The sign tells you the type; the size tells you the strength of the relationship.

Selling one product cheaply to drive sales of a profitable complement. Printers are sold cheaply because ink has inelastic demand and high margins. The negative XED between printers and ink means cheaper printers boost ink demand.

The size (absolute value) tells you how closely related the goods are. A high positive XED = very close substitutes (Coke vs Pepsi). A small positive XED = weak substitutes. XED ≈ 0 = unrelated goods.

Regulators use XED to define markets. If two products have a high positive XED, they are close substitutes and in the same market. This determines whether a merger creates a monopoly or if a firm has market power. High XED = same competitive market.

XED = %ΔQd(Xbox) ÷ %ΔP(PlayStation) = +15% ÷ +10% = +1.5. Positive → substitutes. High value (1.5) → close substitutes. Consumers readily switch from PlayStation to Xbox when PS price rises.

Designer handbags (YED ≈ +2.5): income rises 10% → demand rises 25%. Luxury. Instant noodles (YED ≈ −0.5): income rises 10% → demand FALLS 5%. Inferior good — consumers switch to better food.

PED = (ΔQd/ΔP) × (P/Qd) = −b × (P/Qd). The slope −b is constant along a linear demand curve, but PED CHANGES at every point because P/Qd changes. PED = −1 at the midpoint. |PED| > 1 in the upper half (elastic), |PED| < 1 in the lower half (inelastic).

At P = 20: Qd = 100 − 2(20) = 60. PED = −b × (P/Qd) = −2 × (20/60) = −2 × 0.333 = −0.67. |PED| = 0.67 < 1 → INELASTIC at this point. A 1% price increase leads to only a 0.67% fall in quantity demanded.

Even though the SLOPE (−b) is constant, PED = −b × (P/Qd). As you move DOWN the demand curve: P falls and Qd rises → P/Qd decreases → |PED| decreases. At the top: P high, Q low → elastic. At the midpoint: unit elastic. At the bottom: P low, Q high → inelastic.

YED = %ΔQd / %ΔY. Positive → normal good (luxury if > 1, necessity if 0–1). Negative → inferior good. XED = %ΔQd of good A / %ΔP of good B. Positive → substitutes (higher price of B → more demand for A). Negative → complements.

%ΔQd = (120 − 100)/100 × 100 = 20%. %ΔY = (44,000 − 40,000)/40,000 × 100 = 10%. YED = 20%/10% = +2.0. This is a LUXURY good (normal, YED > 1): demand is income elastic — a 1% rise in income leads to a 2% rise in demand.

Pepsi: XED = +15%/+10% = +1.5 → SUBSTITUTES (positive, high value means close substitutes). Lemons: XED = −5%/+10% = −0.5 → COMPLEMENTS (negative — higher Coke price → less Coke → less demand for lemons to go with Coke).