Price and Income Elasticity of Demand (Edexcel 9BS0 1.2.4–1.2.5)
Price elasticity (PED) and income elasticity (YED) measure how strongly demand reacts to changes in price and income. These are the most heavily examined calculations in Theme 1, and interpreting the number correctly matters as much as computing it.
PED: formula and a worked calculation
Price elasticity of demand measures the responsiveness of quantity demanded to a price change:
PED = % change in quantity demanded ÷ % change in price
Worked example: a supermarket cuts the price of a two-litre milk line from £1.20 to £1.00. Weekly sales rise from 8,000 to 12,000 units.
- % change in price = (1.00 − 1.20) ÷ 1.20 × 100 = −16.7%
- % change in quantity = (12,000 − 8,000) ÷ 8,000 × 100 = +50%
- PED = 50 ÷ −16.7 = −3.0
Because the answer is below −1, demand is price elastic: the volume response outweighs the price cut, so revenue rises from £9,600 to £12,000 a week. PED is almost always negative — price up, quantity down — so examiners care about the size of the number, not the sign. Show every stage of working; method marks survive an arithmetic slip.
Interpreting PED and what determines it
If PED is between 0 and −1, demand is inelastic: a price rise cuts volume only slightly, so total revenue increases. If PED is beyond −1, demand is elastic and a price rise reduces revenue. This single link between elasticity and revenue drives most exam evaluation on pricing.
The main determinants:
- Availability of substitutes — the more close alternatives, the more elastic. Unbranded groceries face many substitutes; a patented medicine faces none.
- Brand loyalty — strong branding makes demand less price-sensitive, which is why Apple and premium trainers sustain price rises that supermarket own-labels never could.
- Necessity versus luxury — essentials such as fuel and bread are inelastic.
- Proportion of income — cheap items are less price-sensitive than big-ticket purchases.
Businesses act on this: firms with inelastic demand nudge prices upward, while firms in elastic markets compete on cost and use promotions to win volume.
YED: formula, worked calculation and business use
Income elasticity of demand measures how demand responds when consumer incomes change:
YED = % change in quantity demanded ÷ % change in real income
Worked examples: incomes rise by 5%. Sales of a premium gym-wear range rise 10%, so YED = 10 ÷ 5 = +2.0 — a luxury, strongly income-elastic. Sales of a value ready-meal line fall 2%, so YED = −2 ÷ 5 = −0.4 — an inferior good, bought less as customers trade up.
The sign matters most: positive YED means a normal good; negative means inferior. The cost-of-living squeeze showed this in reverse — as real incomes fell, Aldi and Lidl grew strongly (their value ranges behave as inferior goods, gaining when incomes drop) while some premium brands stalled. Firms use YED to plan for the economic cycle: a house-builder or holiday firm with high positive YED should expect sharp swings, while a discounter can treat downturns as a growth opportunity and expand store openings into them.
Key terms
Practice questions
Explain one reason why demand for a strongly branded product tends to be price inelastic. [4 marks]
Model answer guidance: Identify brand loyalty as the reason. Develop the chain: loyal customers perceive the brand as different from rivals, so they see fewer acceptable substitutes, meaning a price rise causes only a small fall in quantity and PED stays between 0 and −1. Apply to a branded example such as premium trainers or Apple to secure the application mark.
A firm cuts price by 10% and sales volume rises by 4%. Explain what this suggests about PED and revenue. [4 marks]
Model answer guidance: Calculate PED = 4 ÷ −10 = −0.4, so demand is price inelastic. Develop: the volume gain is proportionately smaller than the price cut, so total revenue falls. Conclude the price cut was a poor decision on revenue grounds, and note the firm would do better holding or raising price if costs allow.
Discuss the usefulness of YED estimates to a discount supermarket planning expansion. [8 marks]
Model answer guidance: Analyse: negative YED for value ranges means demand grows when real incomes fall, so YED tells the discounter that downturns are expansion windows — consistent with Aldi and Lidl gaining share during the cost-of-living squeeze. Counter: YED estimates are based on past data, income changes are hard to forecast, and rivals' price-matching can blunt the effect. Brief judgement on balance.
Assess whether a business should always raise prices when demand is price inelastic. [10 marks]
Model answer guidance: For: with PED between 0 and −1 a price rise lifts revenue and usually profit, since volume falls only slightly. Against: elasticity is not fixed — repeated rises invite substitutes and new entrants, damage brand reputation and may attract regulatory or public criticism, and PED estimates may be inaccurate. Judgement: raise cautiously, monitor the volume response, and remember long-run PED is usually more elastic than short-run.
Assess the value of elasticity calculations to a UK retailer during a period of falling real incomes. [12 marks]
Model answer guidance: For: PED guides which lines can carry price rises to protect margins, while YED identifies which ranges will grow (value, inferior goods) and which will shrink (premium), guiding range and marketing decisions. Against: both measures rely on historical data, consumer behaviour shifts during downturns, and competitor actions can swamp predicted effects. A strong conclusion argues elasticities are directional tools for range planning rather than precise forecasts, most useful when combined with current sales data.
Examiner tips
- Show the formula, the substitution and the answer as three separate lines — method marks are awarded even if the arithmetic slips.
- Interpret every elasticity you calculate: state elastic or inelastic, then link it to total revenue, because the revenue link is where evaluation marks live.
- For YED, comment on the sign first (normal or inferior) and the size second — candidates who ignore the sign misclassify the good and lose the analysis.
In The Business School simulation your students make these exact decisions in a live market against rival firms — every choice mapped to the specification. Free teacher demo, no installs, students join with a PIN.