1. Meaning and degrees of price elasticity
Price elasticity of demand is the responsiveness of quantity demanded to a change in the good's own price. It is a ratio of two percentage changes, so it has no units.
| Degree | Ed | Curve |
|---|---|---|
| Perfectly elastic | ∞ | Horizontal |
| Perfectly inelastic | 0 | Vertical |
| Unitary | 1 | Rectangular hyperbola |
| Relatively elastic | > 1 | Flatter |
| Relatively inelastic | between 0 and 1 | Steeper |
Flat-versus-steep comparisons are valid only at a common point, because Ed also depends on P ÷ Q.
Key terms
- Price elasticity of demand
Percentage change in quantity demanded divided by percentage change in own price.
- Unitary elasticity
Equal percentage changes in price and quantity; total spending unchanged.
2. The percentage (proportionate) method
Ed = (ΔQ ÷ Q) ÷ (ΔP ÷ P) = (ΔQ ÷ ΔP) × (P ÷ Q), where Q and P are the original values. The ratio is negative for a normal demand curve; by convention the minus sign is dropped.
Unknown quantity: percentage change in quantity = Ed × percentage change in price. Unknown price: percentage change in price = percentage change in quantity ÷ Ed.
In ISC 2027, all numericals on price elasticity use this method.
| Step | Working | Result |
|---|---|---|
| Percentage change in quantity | (260 − 200) ÷ 200 × 100 | 30 per cent |
| Percentage change in price | (32 − 40) ÷ 40 × 100 | -20 per cent |
| Ed (minus sign dropped) | 30 ÷ 20 | 1.5 |
| Degree | Ed > 1 | Relatively elastic |
| Step | Working | Result |
|---|---|---|
| Percentage rise in price | (55 − 50) ÷ 50 × 100 | 10 per cent |
| Percentage fall in quantity | 0.8 × 10 | 8 per cent |
| Fall in kites | 8 per cent of 500 | 40 |
| New daily sales | 500 − 40 | 460 kites |
Key terms
- Proportionate method
Another name for the percentage method, using changes divided by original values.
3. The total expenditure (outlay) method
Compare total spending (price × quantity) before and after a price change:
- spending moves opposite to price → elastic;
- spending unchanged → unitary;
- spending moves the same way as price → inelastic.
It gives only the category, not an exact value, and ISC sets no numericals on it.
| When price | Total spending | Demand is |
|---|---|---|
| Falls | Rises | Elastic (Ed > 1) |
| Falls | Stays the same | Unitary (Ed = 1) |
| Falls | Falls | Inelastic (Ed < 1) |
| Rises | Falls | Elastic (Ed > 1) |
| Rises | Rises | Inelastic (Ed < 1) |
Key terms
- Total expenditure (outlay)
Price multiplied by quantity bought: what buyers spend on the good.
4. The point (geometric) method
Ed at a point = lower segment ÷ upper segment of a straight-line demand curve. It is ∞ at the price axis, > 1 above the mid-point, 1 at the mid-point, < 1 below it and 0 at the quantity axis. On a curved demand curve, draw a tangent at the point and use its segments. ISC sets no numericals on this method.
| Position on a straight line | Lower vs upper segment | Ed |
|---|---|---|
| Meets the price axis | Upper segment is zero | ∞ |
| Above the mid-point | Lower longer than upper | Greater than 1 |
| Mid-point | Equal | 1 |
| Below the mid-point | Lower shorter than upper | Less than 1 |
| Meets the quantity axis | Lower segment is zero | 0 |
Key terms
- Lower segment
Part of the demand line from the point to the quantity axis.
- Upper segment
Part of the demand line from the point to the price axis.
5. Factors affecting price elasticity
- Substitutes: more and closer substitutes → more elastic.
- Nature: necessities inelastic, luxuries elastic.
- Share of income: tiny share → inelastic.
- Number of uses: many uses → more elastic.
- Postponement: purchases that can wait → elastic.
- Time period: more elastic in the long run.
- Habits and price level (very cheap or very costly goods) → inelastic.
| Factor | Makes demand more elastic when… | Imagined example |
|---|---|---|
| Substitutes | Many close substitutes exist | One brand of soap |
| Nature of the good | It is a luxury | Air-conditioned holidays |
| Share of income | It takes a large share of income | A new refrigerator |
| Number of uses | It has many uses | Electricity |
| Postponement | Buying can be delayed | A new sofa |
| Time period | The period is long | Petrol over two years |
| Habit | It is not habit-forming | Tea is the opposite case |
| Reason | One brand of biscuits | Wheat flour |
|---|---|---|
| Substitutes | Many other brands | Few close substitutes |
| Nature | Snack, can be skipped | Daily necessity |
| Postponement | Easy | Not possible |
| Conclusion | Elastic | Inelastic |
Key terms
- Necessity
A good bought regularly whatever its price; its demand is inelastic.
6. Income and cross elasticity
Income elasticity = % change in quantity ÷ % change in income: negative for inferior goods, 0 to 1 for necessities, above 1 for luxuries.
Cross elasticity = % change in quantity of X ÷ % change in price of Y: positive for substitutes, negative for complements, zero for unrelated goods.
| Income elasticity | Meaning | Imagined example |
|---|---|---|
| Negative | Inferior good: bought less as income rises | Coarse broken rice |
| Zero | Demand does not change with income | Salt (nearly) |
| Between 0 and 1 | Necessity: rises less than income | Milk |
| Greater than 1 | Luxury: rises more than income | Foreign holidays |
| Pair of goods | Relationship | Sign of cross elasticity |
|---|---|---|
| Tea and coffee | Substitutes | Positive |
| Cars and petrol | Complements | Negative |
| Umbrellas and school bags | Unrelated | Zero |
| Elasticity | Responds to | Formula in words |
|---|---|---|
| Price elasticity | The good's own price | % change in quantity ÷ % change in own price |
| Income elasticity | Consumers' income | % change in quantity ÷ % change in income |
| Cross elasticity | Price of a related good | % change in quantity of X ÷ % change in price of Y |
Key terms
- Income elasticity
Responsiveness of demand to a change in consumers' income.
- Cross elasticity
Responsiveness of demand for one good to the price of another.
Exam tips
Common mistakes
- Dividing by the new price or quantity instead of the original values.
- Forgetting to drop the minus sign, or dropping it without saying so.
- Calling a flatter curve more elastic without noting that the comparison holds at a common point.
- Attempting numericals on the outlay or point method (ISC sets them on the percentage method only).
- Mixing up signs: substitutes have a positive cross elasticity, complements a negative one.
How marks are usually awarded
- 1 mark: one correct option or term.
- 2 marks: formula and answer, or two clear points.
- 3 marks: working, answer and degree, or three points.
- 5 marks: parts answered in order with working and reasons.