Price elasticity of demand and supply, how each is calculated, the meaning of elastic and inelastic, the factors that affect elasticity, and the link between elasticity and revenue.

What this dot point is asking

AQA wants you to define and calculate price elasticity of demand and supply, explain what elastic and inelastic mean, list the factors that affect elasticity, and explain how elasticity affects a firm's total revenue. In the exam this often appears as a short Section A calculation (showing working) plus a 4 to 6 mark "explain" question linking elasticity to revenue or to pricing decisions.

Calculating elasticity

The percentage change in quantity always goes on top and the percentage change in price on the bottom. A percentage change is found with $\frac{\text{new} - \text{old}}{\text{old}} \times 100$. We usually look at the size of the answer, ignoring the minus sign that $PED$ carries because the demand curve slopes downwards (price and quantity move in opposite directions). $PES$ is normally positive, because the supply curve slopes upwards.

Elastic and inelastic

• Elastic demand: size of $PED$ is greater than $1$. Quantity changes by a larger percentage than price.
• Inelastic demand: size of $PED$ is less than $1$. Quantity changes by a smaller percentage than price.
• Unit elastic: $PED$ equals $1$ exactly, so the percentage changes are equal.
• Perfectly inelastic ($PED = 0$) means quantity does not change at all; perfectly elastic demand is the extreme opposite.

Factors affecting elasticity

Demand tends to be more elastic when:

• Substitutes are widely available, so buyers can switch easily (one brand of crisps).
• The good takes up a large share of income, so a price rise really bites (a new car).
• The good is a luxury rather than a necessity, so it is easy to do without.
• Consumers have time to adjust and find alternatives.

Necessities, goods with few substitutes, addictive goods and goods that take up a tiny share of income (salt, a box of matches) tend to be inelastic. Supply is more elastic when firms have spare capacity, can store stock, and have time to expand production. Farm crops are very inelastic in the short run because a harvest cannot be increased once planted.

Elasticity and total revenue

Because $\text{total revenue} = \text{price} \times \text{quantity}$, the effect of a price change on revenue depends entirely on elasticity:

• If demand is inelastic, raising price raises total revenue (the small fall in sales is outweighed by the higher price).
• If demand is elastic, raising price lowers total revenue (sales fall by more than price rises).
• This is why governments tax inelastic goods such as petrol and cigarettes: a tax raises a lot of revenue without cutting sales much.

Try this

Q1. A good has a $PED$ of $0.4$. Is demand elastic or inelastic? [1 mark]

• Cue. Inelastic, because the size is below $1$.

Q2. Explain why demand for petrol tends to be price inelastic. [3 marks]

• Cue. It has few close substitutes and is a necessity for many drivers, so quantity changes little when price rises.