Cambridge A Level Economics 9708
Elasticity
Elasticity measures how much one variable responds to a change in another, and every version is the same fraction: percentage change in the thing responding, divided by percentage change in the thing causing it. Price elasticity of demand (PED) is the one that matters most, and its single most useful consequence is the effect on total revenue — a price cut raises revenue only when demand is elastic.
For Cambridge 9708 the four to know are PED, PES, YED and XED. Two things are examined about each: the sign (what it tells you about the relationship) and the value (how strong the response is). Get those apart and most multiple-choice questions on the topic resolve themselves.
Updated 15 September 2026
Price elasticity of demand
PED is negative for almost every good, because price and quantity demanded move in opposite directions. Questions usually quote the magnitude and expect you to supply the sign — or quote −0.4 and expect you to read it as inelastic. Interpretation is by absolute value:
| |PED| | Demand is | Means |
|---|---|---|
| 0 | Perfectly inelastic | Quantity does not change at all. Vertical demand curve. |
| Between 0 and 1 | Inelastic | Quantity changes proportionately less than price. |
| 1 | Unit elastic | Quantity changes in exact proportion to price. |
| Greater than 1 | Elastic | Quantity changes proportionately more than price. |
| Infinite | Perfectly elastic | Any price rise loses all demand. Horizontal demand curve. |
One subtlety worth carrying into the exam: on a straight-line demand curve the elasticity is different at every point — elastic in the upper half, unit elastic at the midpoint, inelastic in the lower half. A constant gradient does not mean constant elasticity, and questions are built on exactly that confusion.
PED and total revenue
The most-tested consequence. Total revenue is price × quantity, and when price changes the two move opposite ways — so which effect wins depends on elasticity:
| Demand | Price rises | Price falls |
|---|---|---|
| Inelastic | Revenue rises | Revenue falls |
| Elastic | Revenue falls | Revenue rises |
| Unit elastic | Unchanged | Unchanged |
The shortcut: when demand is inelastic, revenue moves with price; when it is elastic, revenue moves against price. This is why a government taxing cigarettes raises revenue while a supermarket discounting a competitive brand raises revenue — opposite actions, opposite elasticities.
What makes demand elastic
- Close substitutes. The dominant factor. One brand of petrol is elastic; petrol as a whole is inelastic.
- Necessity or luxury. Necessities are inelastic; wants are elastic.
- Share of income. A 10% rise in the price of salt is ignored; a 10% rise in the price of a car is not.
- Time. Demand is more elastic in the long run, once buyers can find alternatives or change equipment — the standard explanation for why an oil price rise cuts consumption slowly.
- Addictiveness and habit. Inelastic, which is what makes tobacco and alcohol reliable tax bases.
- Definition of the market. The narrower the definition, the more elastic — because the substitutes are just outside it.
Income elasticity of demand (YED)
Here the sign is the whole point:
- Positive → a normal good: higher income, higher demand. If greater than 1 it is a luxury (income elastic) — demand grows faster than income. Between 0 and 1 it is a necessity.
- Negative → an inferior good: higher income, lower demand, because consumers switch to something better. Bus travel and supermarket value ranges are the standard examples.
The application is forecasting: a firm selling luxuries expects sales to swing violently over the business cycle, while an inferior good is counter-cyclical and sells better in a recession.
Cross elasticity of demand (XED)
- Positive → substitutes. B gets dearer, so people buy more A. The larger the value, the closer the substitutes.
- Negative → complements. B gets dearer, so people buy less of B and therefore less of A — printers and cartridges, cars and fuel.
- Zero → unrelated goods.
Its use is competitive strategy and market definition: a high positive XED between two products means they are in the same market and their pricing is interdependent — which links straight to oligopoly.
Price elasticity of supply (PES)
Normally positive, since supply rises with price. Supply is more elastic when the firm holds spare capacity or stock, when production can be scaled quickly, when factors of production are mobile, and — above all — when there is more time: supply is often perfectly inelastic in the very short run (a crop already harvested) and elastic in the long run.
Worked example
Worked example
A train operator raises fares from $8 to $9 and finds weekly passenger numbers fall from 40 000 to 37 000. Calculate PED, and advise whether the fare rise increased revenue.
Percentage changes, each against its original value:
% change in quantity = (37 000 − 40 000) ÷ 40 000 × 100 = −7.5%
% change in price = (9 − 8) ÷ 8 × 100 = +12.5%
PED = −7.5 ÷ 12.5 = −0.6. The absolute value is below 1, so demand is inelastic — passengers respond proportionately less than the fare changed, which is what you would expect for commuters with few alternatives.
Revenue confirms it: before, 8 × 40 000 = $320 000; after, 9 × 37 000 = $333 000. Revenue rose by $13 000, exactly as the inelastic rule predicts for a price rise.
The evaluation a longer question wants: this is a short-run figure. Over a year some commuters will move to driving or change job — demand becomes more elastic with time — so the revenue gain may not persist, and it says nothing about profit, since costs may not have fallen with the 3 000 lost passengers.
Where elasticity decides the answer
Tax incidence
The burden of an indirect tax falls mainly on whichever side is less elastic, because that side has fewer alternatives. With inelastic demand and elastic supply, consumers pay most of the tax — which is why taxes on tobacco and fuel raise revenue effectively but cut consumption only a little. That trade-off is the heart of most market-failure evaluation.
Firms' pricing
A firm raises price where demand is inelastic and cuts it where demand is elastic. It also explains price discrimination: charge the inelastic segment (the business traveller) more and the elastic segment (the student) less, provided the markets can be kept apart.
Agriculture and commodities
Inelastic demand plus inelastic short-run supply is why farm incomes swing so violently: a good harvest raises quantity, and because demand is inelastic the price falls proportionately more, so total revenue falls after a bumper crop. This is the standard argument for buffer stocks and price support.
Devaluation and the trade balance
A devaluation improves the current account only if demand for exports and imports is elastic enough — the Marshall–Lerner condition, that the elasticities sum to more than one. In the short run they often are not, so the balance worsens before it improves: the J-curve.
Common mistakes
1.Elasticity confused with the gradient
A straight demand curve has one gradient but a different elasticity at every point — elastic above the midpoint, inelastic below it.
2.Percentage change taken from the new value
Always divide the change by the original value. Using the new one gives a different number and a possibly different classification.
3.PED and YED signs mixed up
A negative PED is normal and says nothing special. A negative YED is the informative one — it means an inferior good.
4.Elastic demand assumed to mean 'sensitive customers' only
It is a measured proportion, not an impression. |PED| > 1 means the quantity response is proportionately larger than the price change — that is the definition to quote.
5.Revenue and profit treated as the same
Elasticity tells you what happens to revenue. Whether profit rises depends on what happens to costs as output changes.
Common questions
What is the formula for price elasticity of demand?
Percentage change in quantity demanded divided by percentage change in price. It is normally negative; demand is inelastic if the absolute value is below 1 and elastic if it is above 1.
If demand is inelastic, should a firm raise or lower its price?
Raise it, if revenue is the objective: with inelastic demand the quantity lost is proportionately smaller than the price gained, so total revenue rises. Whether profit rises also depends on costs.
What does a negative income elasticity of demand mean?
That the good is inferior — demand falls as income rises, because consumers switch to something they prefer. Positive YED means a normal good, and above 1 means a luxury.
What does cross elasticity of demand tell you?
Whether two goods are substitutes or complements. A positive XED means substitutes (the dearer B gets, the more A is bought); a negative XED means complements; around zero means the goods are unrelated.
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