Should a shop put its prices up or down to earn more? There is no single answer — it depends entirely on how its customers react. That is why firms and governments care about PED: it turns a number into a decision.
📘 What you need to know
Total revenue (TR) = price × quantity sold. It is money coming in, not profit.
If demand is elastic, cut the price to raise revenue. Quantity rises by proportionally more than price falls.
If demand is inelastic, raise the price to raise revenue. Quantity falls by proportionally less than price rises.
If demand is unit elastic, revenue does not change at all — the two effects cancel out.
Firms use this for pricing and for price discrimination (charging different groups different prices).
Governments tax inelastic goods to raise revenue reliably, and subsidise elastic goods when they want consumption to jump.
Primary commodities (crops, metals, oil) tend to be inelastic; manufactured goods tend to be more elastic.
Total revenue: a rectangle on the diagram
Total revenue is easy to picture. Take the price on the vertical axis, take the quantity on the horizontal axis, and multiply them. That is a rectangle underneath the point where you are trading.
Total revenue
TR = P × Q
When a firm changes its price, that rectangle changes shape. It loses some area on one side and gains some on the other, and PED decides which piece is bigger.
Elastic demand: cut the price
With elastic demand a small price cut brings in a lot of extra customers. The firm gives up a little on every unit it was already selling, but sells many more units. The gain beats the loss, so revenue rises.
Every price change has a losing side and a winning side. Elasticity is simply the rule for which side wins.
WORKED EXAMPLE
A gym charges $50 a month and has 1,000 members. PED for membership is −2. It cuts the price by 10%. Calculate total revenue before and after. [4]
Step 1: TR before50 × 1,000 = $50,000Step 2: new price50 − 10% = $45Step 3: new quantity, using %QD = PED × %P−2 × −10 = +20% → 1,000 × 1.2 = 1,200 membersStep 4: TR after45 × 1,200 = $54,000TR rises from $50,000 to $54,000Demand was elastic, so cutting the price was the right call.
Inelastic demand: raise the price
Now flip it. If buyers have nowhere else to go, the firm can charge more and lose only a handful of customers. It gains on every unit it still sells, and the small loss of sales does not undo that.
The steeper the demand curve, the thinner the red strip — and the more tempting a price rise becomes.
WORKED EXAMPLE
A bus company sells 400 tickets a day at $2.50. PED is −0.4. It raises the fare by 20%. Calculate the change in total revenue. [4]
Step 1: TR before2.50 × 400 = $1,000Step 2: new price2.50 + 20% = $3.00Step 3: new quantity−0.4 × 20 = −8% → 400 × 0.92 = 368 ticketsStep 4: TR after3.00 × 368 = $1,104TR rises by $104 a dayDemand was inelastic, so the fare rise worked. With PED = −2 it would have backfired.
The rule in one table
If you remember nothing else from this page, remember this grid. It answers most Paper 1 and Paper 2 revenue questions on its own.
PED
If the firm raises price
If the firm cuts price
Best move for revenue
Elastic (bigger than 1)
TR falls
TR rises
Cut the price
Inelastic (smaller than 1)
TR rises
TR falls
Raise the price
Unit elastic (exactly 1)
TR unchanged
TR unchanged
Price makes no difference
Revenue is not profit. A price cut can raise revenue and still leave a firm worse off, because serving 200 extra customers costs money. If a question mentions costs, say so — it is an easy evaluation point.
Why firms care
Pricing. Knowing PED tells a firm which way to move its price to earn more.
Price discrimination. Different groups have different elasticities, so firms split them up. Students and pensioners get cheap cinema tickets because their demand is elastic; a business traveller booking a flight the night before pays far more because theirs is not.
Reacting to rivals. If a competitor cuts prices, a firm with many close substitutes must respond quickly, because its demand is elastic.
Branding and loyalty. Advertising exists partly to make demand less elastic. A customer who believes nothing else will do stops shopping around.
Why governments care
Raising tax revenue. Taxes land on inelastic goods — fuel, tobacco, alcohol — because people keep buying them, so the revenue is large and predictable.
Who actually pays. When demand is inelastic, firms can pass most of an indirect tax on to consumers in a higher price. The more inelastic demand is, the more of the tax the buyer carries.
The awkward trade-off. A tax meant to stop people consuming something works badly on inelastic goods, because that is exactly when quantity hardly falls. Great for revenue, weak for behaviour change.
Subsidies. Subsidising an elastic good gives a big jump in quantity for the money spent — useful for things the government wants people to use more of, like public transport or solar panels.
WORKED EXAMPLE
A government wants to raise tax revenue. It is choosing between a tax on cigarettes (PED −0.3) and a tax on restaurant meals (PED −1.8). Which should it choose, and what is the drawback? [4]
Step 1: compare the two valuesCigarettes are inelastic, restaurant meals are elastic.Step 2: what happens when each is taxed
Tax on cigarettes: the price rises but quantity barely falls, so a lot is still sold and taxed. Tax on meals: quantity falls sharply, so there is less to tax.
Step 3: chooseTax cigarettes — larger and steadier revenue.Step 4: evaluate
Because demand hardly falls, the tax does little to reduce smoking, and it takes a bigger share of income from poorer smokers, so it is regressive.
Tax the inelastic good; accept that it changes behaviour very littleThe strength of the policy for revenue is exactly its weakness for health.
Primary commodities versus manufactured goods
A favourite exam comparison. Raw materials and crops usually have low PED; finished manufactured goods usually have higher PED. Run SPLAT through both and the reason becomes obvious.
SPLAT factor
Primary commodities (wheat, copper, oil)
Manufactured goods (phones, cars, trainers)
Substitutes
Few. A factory needing copper wiring cannot easily swap it for something else.
Many. One brand of phone can be replaced by a dozen others.
Proportion of income
Small. The raw material is a slice of the final cost, so a price change is barely felt.
Larger. A car or laptop is a big chunk of a household budget.
Luxury or necessity
Necessity. These are the inputs that everything else is made from.
Often closer to a luxury, and easy to put off buying.
Addictiveness
Not addictive, but industry depends on them, which has the same effect.
Brand loyalty can create habit, though rivals limit it.
Time
Growing or mining more takes seasons or years, so buyers have little room to adjust.
Production and switching happen quickly.
Why this matters beyond the exam. Inelastic demand is one reason commodity prices swing so violently. A small change in the harvest moves the price a long way, which makes life unstable for farmers and for countries that depend on exporting one crop.
🧩 Answering a “should they change the price?” question
State the PED and say whether demand is elastic or inelastic.
Give the rule: elastic means cut, inelastic means raise.
Explain with proportions: quantity changes by more (or less) than price.
Calculate TR before and after if you have the numbers.
Evaluate: revenue is not profit, PED changes over time, and the estimate may be unreliable.
💡 Exam tip
Write TR = P × Q at the top of your working. It keeps you from confusing revenue with profit.
Say why revenue moves, not just that it moves: quantity changed proportionally more, or less, than price.
Shade the lost and gained areas on your diagram and label them. It is quick and it earns diagram marks.
In evaluation, question the PED figure itself. It is an estimate from past data and can change as rivals and habits change.
For tax questions, always split the two aims: raising revenue and changing behaviour. Inelastic goods are good for one and bad for the other.
Use real examples — fuel duty, tobacco tax, off-peak fares. They make an evaluation paragraph much stronger.
⚠ Common mix-up
Saying revenue always rises when price rises. It only does when demand is inelastic.
Treating total revenue as profit. Costs have not been taken off yet.
Forgetting that PED varies along the curve, so the same firm can be in the elastic range at one price and the inelastic range at another.
Assuming a tax on an inelastic good will cut consumption a lot. It will not — that is the point of the good being inelastic.
Mixing up who pays the tax. The firm hands it over, but with inelastic demand the consumer bears most of it.
Claiming all primary commodities are inelastic and all manufactured goods elastic. It is a tendency, not a law. Say “tends to be”.
Up next: Income Elasticity of Demand (YED) — same style of calculation, but now we change income instead of price and find out which goods people buy more of as they get richer.
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