Price elasticity of demand

Also called: PED, Elasticity of demand, eD · Topic: Consumer Behaviour, Demand and Elasticity · NCERT: Class 12, Ch 2 "Theory of Consumer Behaviour"

Meaning

Price elasticity of demand (eD) measures how strongly the quantity demanded of a good reacts when its own price changes. It is the percentage change in quantity demanded divided by the percentage change in price.

Formula: eD = % change in quantity demanded ÷ % change in price = (ΔQ/Q) × (P/ΔP)

• ΔQ is the change in quantity and ΔP is the change in price.
• Q and P are the starting quantity and price.

eD is a pure number with no unit, and its sign is negative. By convention we quote it in absolute value, written |eD|. It tells a seller or a government what happens to sales, and to total spending, when a price changes. That is why it drives decisions on taxes, fuel pricing and farm support.

Explanation

How it is measured

• It is a pure number. The top and the bottom are both percentages, so the units cancel. This lets you compare rice (kg), milk (litres) and cars (numbers).
• Its sign is negative. The law of demand says that when price rises, quantity demanded falls. So the two changes have opposite signs.

• "eD = −0.5" is read as "elasticity of 0.5".

• WHO defines it in an equivalent way: the % change in quantity consumed when the price changes by 1% [2].

Worked example: bananas (Class 12, Example 2.2)

• Price rises from ₹5 to ₹7, and quantity falls from 15 to 12.
• %ΔQ = (12 − 15)/15 × 100 = −20%
• %ΔP = (7 − 5)/5 × 100 = +40%
• |eD| = 20/40 = 0.5. Demand is inelastic.

The problem with the starting-value method (beyond NCERT)

• Run the same example in reverse (₹7 → ₹5, quantity 12 → 15). Now |eD| = 25/28.6 = 0.875, not 0.5.
• The arc (midpoint) formula fixes this. It divides by the average of the old and new values:
• eD = [ΔQ / ((Q₁ + Q₂)/2)] ÷ [ΔP / ((P₁ + P₂)/2)]
• Bananas: (3/13.5) ÷ (2/6) = 0.67, whichever direction the price moves.

Degrees of elasticity

Type	|eD|	Meaning	Curve / typical case
Perfectly inelastic	0	Quantity does not change at all	Vertical curve
Inelastic	< 1	%ΔQ < %ΔP	Essentials (food, salt, medicine)
Unitary elastic	= 1	%ΔQ = %ΔP, so spending is unchanged	Rectangular hyperbola
Elastic	> 1	%ΔQ > %ΔP	Luxuries
Perfectly elastic	∞	At any price above P̄, quantity falls to zero	Horizontal curve

• Elasticity belongs to a point on the curve, not to the good. The same good can be elastic at one price and inelastic at another.
• Along a straight-line demand curve q = a − bp:
• eD = −bp/q = −bp/(a − bp)
• The slope (−b) is fixed, but elasticity changes because p/q changes.
• At p = 0 (on the quantity axis), eD = 0.
• At the midpoint p = a/2b, |eD| = 1.
• At q = 0 (on the price axis), eD = ∞.

• Example: for D(p) = 10 − 3p at p = 5/3, q = 5 and eD = −3 × (5/3)/5 = −1. This price is exactly the midpoint.

• Geometric measure: eD = lower segment ÷ upper segment of the line. If the lower part is 3 cm and the upper part is 6 cm, |eD| = 0.5.

• Curves with constant elasticity:
• Vertical: 0 everywhere.
• Horizontal: ∞ everywhere. This is the demand curve facing a perfectly competitive firm (a firm that can sell any amount at the market price but nothing at a higher price).
• Rectangular hyperbola (p × q = constant): 1 everywhere. For example, if pq = 100, spending is ₹100 at ₹10 and at ₹20. The average fixed cost (AFC) curve has the same shape.

What makes it rise or fall

• Nature of the good (NCERT):
• Necessities such as food are inelastic.

• Luxuries, which people can put off buying, are elastic.

• Close substitutes (NCERT): food as a whole is inelastic, but one variety of pulses is elastic, because buyers simply switch to another variety.

• Share of the budget: salt is inelastic because it is a tiny part of spending. Cars are elastic because they take a large part of income.
• Time horizon: demand is more elastic in the long run, because people have time to find substitutes, such as switching to EVs.

• The survey range of −0.6 to −0.9 for petrol (gasoline) demand in other countries is a long-run estimate [4].

• Habit or addiction: tobacco and alcohol are inelastic. Cigarette elasticity is "nearly always" between 0 and −1 [2].

• Income of the buyer: poorer buyers react more, because a price rise takes a bigger share of their income.
• Breadth of definition: "food" is less elastic than "basmati rice of brand X". The narrower the category, the more substitutes it has.
• Number of uses: goods with many uses, such as electricity and milk, are more elastic. When the price rises, buyers can cut the less important uses.

Elasticity and total spending

• Expenditure = P × Q. This is what buyers spend, and it is also the seller's total revenue.
• The rule:
• Elastic: price and spending move in opposite directions. A price cut raises spending.
• Inelastic: price and spending move in the same direction. A price rise raises spending.

• Unitary: spending does not change.

• Why the rule works: for small changes, ΔE ≈ Δp · q(1 + eD).

• If eD < −1, (1 + eD) is negative, so spending moves opposite to price.

• If eD > −1, (1 + eD) is positive, so spending moves with price.

• Example (Class 12): eD = −0.2 and price rises 10%.

• Quantity falls 2%.

• New spending = 1.10 × 0.98 = 1.078, a rise of about 7.8%.

• Example (Class 12): a 4% price cut raises spending by 2%.

• Price fell and spending rose, so demand is elastic.
• Quantity rises by about 6.25%, so |eD| ≈ 1.56.

In India

• Fuel. An IMF working paper (Kapur and Mohan, April 2014) estimated India's price elasticities [4]:
• petrol: −0.66
• diesel: −0.36
• kerosene: −0.54

• All three are inelastic, but demand still responds to price.

• The diesel example from the same paper [4]:

• Diesel was under-priced by about ₹11 per litre in 2011-12 and 2012-13. That was about 25% of the actual price.
• A 25% price rise would have cut diesel use by about 0.36 × 25% ≈ 9%.

• Oil imports and the current account deficit (how much more a country pays to the rest of the world than it receives) would each have been about 0.5% of GDP lower in each of those years.

• Tobacco by income group. A study used 2011-12 Consumer Expenditure Survey data from 101,662 households (Selvaraj, Srivastava and Karan) [3]:

• cigarettes: −0.832 (poorest) vs −0.2645 (richest)
• bidis: −0.4328 (poorest) vs −0.0815 (richest)

• leaf tobacco: −0.557 (poorest) and −0.4537 (middle group)

• Tax design. Tobacco carries GST at the highest rate plus extra cesses. Petroleum products stay outside GST. Both are goods with inelastic demand, so they are dependable sources of tax revenue.

• Farm prices. Food demand is inelastic, so a bumper harvest can push prices down so far that farmers' total income falls. This is one reason India uses MSP (the minimum support price at which the government offers to buy crops) and buffer stocks.

Don't confuse with

• Slope of the demand curve: slope is Δp/Δq, measured in units and constant along a straight line. Elasticity is unit-free and changes from point to point on that same line. A steeper line does not mean "inelastic at every point".
• Point (NCERT) method vs arc (midpoint) method: the NCERT method divides by the starting values, so a price rise and a price fall give different answers (0.5 vs 0.875 for bananas). The arc method divides by the averages and gives 0.67 in both directions.
• Perfectly elastic vs perfectly inelastic: perfectly elastic is a horizontal curve (∞), as faced by a perfectly competitive firm. Perfectly inelastic is a vertical curve (0).
• Unitary elasticity vs a straight line: only a rectangular hyperbola (pq = constant) has |eD| = 1 everywhere. A straight line has |eD| = 1 only at its midpoint.

Prelims Hooks

• eD = (ΔQ/Q) × (P/ΔP). It is unit-free and negative, but quoted in absolute value.
• On a straight-line demand curve, elasticity is 0 on the quantity axis, 1 at the midpoint and ∞ on the price axis. The geometric measure is lower segment ÷ upper segment.
• Rectangular hyperbola: |eD| = 1 everywhere and spending stays constant. The AFC curve has the same shape.
• Trap: with inelastic demand, a price rise increases total spending. With elastic demand, a price cut increases it.
• IMF (2014) estimates for India: petrol −0.66, diesel −0.36, kerosene −0.54. All three are inelastic [4].
• WHO: cigarette elasticity clusters around −0.4 in high-income countries and ranges from −0.2 to −0.8 in low- and middle-income countries (IARC, 2011) [2].

Mains Points

• Taxing goods with inelastic demand raises revenue and still cuts use.
• The tax raises the price, but quantity falls by a smaller percentage, so government revenue rises. WHO calls this the "win-win" of tobacco excise [2].
• Poorer and younger smokers are the most price-responsive, so they cut back most. This reduces their health costs and weakens the charge that such taxes are regressive (take a bigger share of income from the poor) [2][3].
• Rates must rise evenly across cigarettes, bidis and leaf tobacco. Otherwise smokers switch to the cheaper product [2].

• Trade-off: on a necessity with inelastic demand, the same tax falls hardest on the poor. There, the revenue gain comes at the cost of equity.

• Elasticity evidence supports fuel pricing reform.

• Diesel demand does respond to price (−0.36) [4].
• So market-linked prices cut consumption and oil imports. Market pricing of diesel in 2011-13 would have lowered the current account deficit by about 0.5% of GDP a year [4].

• This supports ending price controls (petrol in 2010, diesel in 2014) and shifting to targeted subsidies.

• The "paradox of plenty" in farming.

• Food demand is inelastic, so a bumper harvest cuts prices by more than output rises, and farm income can fall.
• This is the case for MSP, buffer stocks and better storage to keep farm incomes steady.

Related concepts

• Elastic demand
• Inelastic demand
• Unitary elastic demand
• Perfectly elastic demand
• Perfectly inelastic demand
• Elasticity along a linear demand curve
• Geometric measure of elasticity of demand
• Rectangular hyperbola
• Determinants of price elasticity of demand
• Elasticity and expenditure

Read more

• Price elasticity of demand: measurement, determinants and expenditure