How responsive are demand and supply to changes in price and income, and why does that matter?
Price, income and cross elasticity of demand and price elasticity of supply, their calculation, determinants, and applications to revenue, taxation and producers.
A focused CCEA A-Level Economics answer on elasticity, covering price, income and cross elasticity of demand and price elasticity of supply, how each is calculated and interpreted, the determinants of each, and applications to total revenue, taxation incidence and producer decisions, with worked calculations.
Reviewed by: AI editorial process; not yet individually human-reviewed
Have a quick question? Jump to the Q&A page
Jump to a section
What this dot point is asking
CCEA wants you to define, calculate and interpret the four elasticities - price elasticity of demand (PED), income elasticity of demand (YED), cross elasticity of demand (XED) and price elasticity of supply (PES) - explain what determines each, and apply them to total revenue, the incidence of taxation, and the decisions of firms and governments.
Price elasticity of demand
The value is interpreted by its size: perfectly inelastic (0), inelastic (between 0 and 1), unit elastic (1), elastic (greater than 1), and perfectly elastic (infinite). The main determinants are: the number and closeness of substitutes (more substitutes means more elastic), whether the good is a necessity or luxury, the proportion of income it takes, whether it is habit-forming or addictive, and time (demand is more elastic in the long run as buyers adjust).
Income elasticity of demand
The sign and size classify the good. A positive YED means a normal good (demand rises with income); within this, a value greater than 1 is a luxury (income elastic) and between 0 and 1 is a necessity (income inelastic). A negative YED means an inferior good, whose demand falls as income rises (for example, supermarket value ranges). YED helps firms forecast demand over the business cycle and helps an economy understand structural change as it grows richer.
Cross elasticity of demand
The sign reveals the relationship. Positive XED means the goods are substitutes (a rise in the price of one raises demand for the other, for example two brands of butter). Negative XED means they are complements (a rise in the price of one lowers demand for both, for example printers and ink). A value near zero means the goods are unrelated. The larger the value, the stronger the relationship, which matters for firms gauging the threat from rivals.
Price elasticity of supply
Supply is more elastic when firms have spare capacity and stocks, when production can be expanded quickly, when factors are mobile, and, above all, over a longer time period. In the very short run (momentary period) supply is often near perfectly inelastic; in the long run firms can build new capacity, so supply is more elastic. This is why agricultural prices swing sharply after a harvest shock: supply cannot respond quickly.
Try this
Q1. A good has an income elasticity of demand of -0.4. Classify the good and explain. [3 marks]
- Cue. Negative YED means an inferior good; demand falls as income rises, for example budget food ranges.
Q2. Calculate PES when a 20 percent rise in price causes a 10 percent rise in quantity supplied, and state whether supply is elastic or inelastic. [3 marks]
- Cue. PES equals 10 divided by 20 equals 0.5; less than 1, so supply is inelastic.
Q3. Explain why a government wanting to raise tax revenue might place an indirect tax on a good with inelastic demand. [6 marks]
- Cue. With inelastic demand, quantity falls little when the tax raises price, so revenue stays high and most of the burden falls on consumers.
Exam-style practice questions
Practice questions written in the style of CCEA exam questions on this dot point, with worked answer explainers. The year tag is the paper they imitate, not the source.
CCEA AS 16 marksExplain the relationship between price elasticity of demand and total revenue.Show worked answer →
Worth 6 marks. Markers reward the link between the value of PED and what happens to revenue when price changes, ideally with a numerical or diagrammatic illustration.
Inelastic demand (PED between 0 and 1): quantity changes proportionately less than price. A price rise therefore raises total revenue, and a price cut lowers it, because the price change dominates.
Elastic demand (PED greater than 1): quantity changes proportionately more than price. A price rise lowers total revenue and a price cut raises it, because the quantity change dominates.
Unit elastic (PED equals 1): revenue is unchanged when price changes.
Application: this is why a firm with an inelastic product can raise revenue by raising price, while a firm facing elastic demand should consider price cuts to grow revenue.
CCEA AS 18 marksExamine the usefulness of price elasticity of demand to a business setting its prices.Show worked answer →
Worth 8 marks. A strong answer applies PED to pricing decisions and then evaluates the limits of the concept.
Pricing: knowing PED tells a firm whether raising price will raise revenue. If demand is inelastic, the firm can raise price to increase revenue; if elastic, it should consider lowering price.
Wider decisions: PED guides discounting, price discrimination between elastic and inelastic markets, and forecasting the effect of a tax.
Limitations: PED is hard to measure accurately, it changes over time and over the price range, it ignores competitors' reactions, and revenue is not the same as profit, so costs must also be considered.
Judgement: PED is a valuable guide to pricing but must be combined with cost data, knowledge of rivals and the long-run effect on customers, so it informs rather than determines the decision.
Related dot points
- The determinants of demand and supply, movements along and shifts of the curves, market equilibrium and disequilibrium, and consumer and producer surplus.
A focused CCEA A-Level Economics answer on demand and supply, covering the laws of demand and supply, the determinants that shift each curve, the difference between movements and shifts, how equilibrium price and quantity are set, disequilibrium, and consumer and producer surplus, with a worked equilibrium analysis.
- The fundamental economic problem of scarcity, opportunity cost, the factors of production, the production possibility frontier, and the market, command and mixed economic systems.
A focused CCEA A-Level Economics answer on the basic economic problem, covering scarcity, opportunity cost, the four factors of production, the production possibility frontier and its shifts, and the market, command and mixed economic systems, with worked PPF reasoning and exam technique.
- Methods of government intervention - indirect taxes, subsidies, regulation, price controls, tradable permits and state provision - their effects, and the causes of government failure.
A focused CCEA A-Level Economics answer on government intervention, covering indirect taxes, subsidies, regulation, maximum and minimum prices, tradable pollution permits, provision of public and merit goods and information, the incidence of taxation, and the causes of government failure, with worked tax incidence.
- The functions of the price mechanism, the inter-relationships between markets, and the theory of consumer utility including marginal utility and the paradox of value.
A focused CCEA A-Level Economics answer on the price mechanism and consumer utility, covering the signalling, incentive and rationing functions of prices, how related markets interact, total and marginal utility, the law of diminishing marginal utility, and the diamond-water paradox of value, with worked reasoning.
Sources & how we know this
- CCEA GCE Economics specification — CCEA (2016)