2.2 Price Elasticity, Income Elasticity and Cross Elasticity of Demand

2026 Syllabus Objectives

By the end of this topic, you should be able to:

  1. Define price elasticity of demand (PED), income elasticity of demand (YED), and cross elasticity of demand (XED).
  2. Write the formulae for PED, YED, and XED and use them to calculate values.
  3. Explain what the size and sign (+ or –) of the PED, YED, and XED coefficient tells us.
  4. Describe the different elasticity values: perfectly elastic, highly elastic, unitary elastic, highly inelastic, and perfectly inelastic.
  5. Explain how PED varies along a straight-line demand curve.
  6. Identify the factors that affect PED, YED, and XED.
  7. Explain the relationship between PED and total expenditure.
  8. Explain how PED, YED, and XED help firms and governments make decisions.

Section 1: What is Elasticity?

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Elasticity is a way of measuring how responsive something is to a change in something else. In economics, we ask: if one thing changes (like price or income), how much does another thing change (like the quantity people want to buy)?

Think of it like a rubber band. A stretchy rubber band represents something very responsive — a small pull causes a big stretch. A stiff rubber band represents something less responsive — even a big pull only causes a small stretch.

There are three types of demand elasticity you need to know:

  • PED — how responsive quantity demanded is to a change in price
  • YED — how responsive quantity demanded is to a change in income
  • XED — how responsive quantity demanded of one good is to a change in the price of another good

Section 2: Price Elasticity of Demand (PED)

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Definition

Price Elasticity of Demand (PED) measures how much the quantity demanded of a good changes when its price changes.

In simple terms: if the price goes up, how much will people cut back on buying it?

Formula

PED=% change in quantity demanded% change in pricePED = \frac{\% \text{ change in quantity demanded}}{\% \text{ change in price}}

You can also write it as:

PED=ΔQDΔP×P1QD1PED = \frac{\Delta QD}{\Delta P} \times \frac{P_1}{QD_1}

Where:

  • ΔQD = change in quantity demanded (new quantity minus original quantity)
  • ΔP = change in price (new price minus original price)
  • P₁ = original price
  • QD₁ = original quantity demanded

How to Calculate PED — Step by Step

Example: The price of a chocolate bar rises from USD 1.00 to USD 1.20. As a result, weekly sales fall from 500 bars to 400 bars.

Step 1: Find the % change in quantity demanded.

  • Change in QD = 400 – 500 = –100
  • % change in QD = (–100 ÷ 500) × 100 = –20%

Step 2: Find the % change in price.

  • Change in P = 1.20 – 1.00 = 0.20
  • % change in P = (0.20 ÷ 1.00) × 100 = +20%

Step 3: Divide.

  • PED = –20% ÷ 20% = –1

Important: PED is almost always a negative number because price and quantity demanded move in opposite directions (this is the law of demand — when price goes up, demand goes down). In most cases, economists ignore the negative sign and just look at the size of the number.

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