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How do the four elasticities measure responsiveness, and why do they matter for revenue and policy?

1.2 Elasticities: price, income and cross elasticity of demand and price elasticity of supply, their calculation and determinants, and the link between PED and total revenue.

An OCR H460 answer to the four elasticities, covering price, income and cross elasticity of demand and price elasticity of supply, how each is calculated and interpreted, their determinants, and the link between price elasticity of demand and total revenue.

Generated by Claude Opus 4.812 min answer

Reviewed by: AI editorial process; not yet individually human-reviewed

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  1. What this dot point is asking
  2. Price elasticity of demand (PED)
  3. Income elasticity of demand (YED)
  4. Cross elasticity of demand (XED)
  5. Price elasticity of supply (PES)
  6. PED and total revenue
  7. Examples in context
  8. Try this

What this dot point is asking

OCR wants you to define, calculate and interpret the four elasticities (PED, YED, XED and PES), to explain what determines each, and to use price elasticity of demand to predict the effect of a price change on a firm's total revenue. Elasticity is one of the most heavily examined quantitative skills, so the formulas must be automatic.

Price elasticity of demand (PED)

The main determinants of PED are: the availability of close substitutes (more substitutes means more elastic), whether the good is a necessity or a luxury (necessities are inelastic), the proportion of income spent on it (a bigger share means more elastic), the time period (demand is more elastic in the long run as buyers adjust), and whether the good is addictive or habitual (which makes it inelastic).

Income elasticity of demand (YED)

YED matters for firms forecasting sales over the economic cycle: demand for luxuries (foreign holidays, new cars) swings sharply with income, while demand for staples and inferior goods is more stable or even rises in a downturn.

Cross elasticity of demand (XED)

The size of XED shows how close the relationship is: a high positive value means strong substitutes (two brands of butter), while a large negative value means strong complements (consoles and their games).

Price elasticity of supply (PES)

Supply is more elastic when there is spare capacity, when stocks can be drawn down, when production can be scaled up quickly, and over longer time periods. Goods with long production lags (agricultural crops, mined minerals) have very inelastic supply in the short run.

PED and total revenue

This is why firms with pricing power and inelastic demand (utilities, addictive products) can raise prices to lift revenue, while firms in competitive markets with elastic demand dare not. It also explains why a government raises tobacco duty to boost revenue: demand is inelastic.

Examples in context

  • Tobacco and alcohol duties. Inelastic demand means higher duty raises substantial revenue and only modestly cuts consumption, the policy rationale for both taxes.
  • Public transport fares. Commuter rail demand is fairly inelastic in the short run, so fare rises raise revenue but face political resistance.
  • Smartphones and apps. Strong negative XED between handsets and their app ecosystems locks consumers into a platform, a key competition concern.

Try this

Q1. A good has YED of −0.4-0.4. State what type of good this is and explain. [3 marks]

  • Cue. Negative YED means an inferior good; demand falls as income rises.

Q2. Explain why the demand for petrol is more price-inelastic in the short run than the long run. [4 marks]

  • Cue. Few short-run substitutes and habit; over time consumers switch to fuel-efficient or electric cars, raising elasticity.

Exam-style practice questions

Practice questions written in the style of OCR exam questions on this dot point, with worked answer explainers. The year tag is the paper they imitate, not the source.

OCR H460/01 20194 marksWhen the price of a rail season ticket rises from £2,000\pounds 2{,}000 to £2,200\pounds 2{,}200, the number sold falls from 50,000 to 47,000. Calculate the price elasticity of demand and state whether demand is elastic or inelastic.
Show worked answer →

A short calculate question. PED is the percentage change in quantity demanded divided by the percentage change in price.

Percentage change in quantity: 47,000−50,00050,000×100=−6%\frac{47{,}000 - 50{,}000}{50{,}000} \times 100 = -6\%. Percentage change in price: 2,200−2,0002,000×100=+10%\frac{2{,}200 - 2{,}000}{2{,}000} \times 100 = +10\%.

PED=−610=−0.6\text{PED} = \frac{-6}{10} = -0.6. The absolute value is less than 1, so demand is price-inelastic. Markers reward both percentage changes, the correct ratio (with the minus sign), and the inelastic conclusion. A common slip is to drop the sign or to invert the ratio.

OCR H460/01 202112 marksAssess the usefulness of price elasticity of demand to a firm setting the price of its product.
Show worked answer →

A levels-of-response question. Knowledge and application: define PED and explain the link to total revenue. If demand is inelastic (∣PED∣<1|\text{PED}| < 1), raising price raises revenue; if elastic (∣PED∣>1|\text{PED}| > 1), cutting price raises revenue. A firm can use PED to set a revenue-maximising price.

Analysis: PED also guides how to respond to a cost rise (a firm facing inelastic demand can pass on most of a tax) and whether to use price discrimination.

Evaluation: PED is hard to measure precisely, changes along the demand curve and over time, and ignores costs (revenue is not profit). Competitors' reactions, branding and non-price factors also matter. Conclude with a supported judgement, for example that PED is a useful guide but only alongside cost and competitive information.

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