Price Elasticity — Calculations and Applications

#Pearson Edexcel IAL Economics WEC11/01

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#PROBABILITY: 🔴 HIGH — Tested in Section B every single series

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#THE THREE ELASTICITY FORMULAS — WITH CONFIRMED ERRORS

PED = % change in quantity demanded / % change in price

• Negative value expected (inverse relationship)
• If |PED| > 1: price-elastic (quantity response > price change proportionally)
• If |PED| < 1: price-inelastic (quantity response < price change proportionally)
• If |PED| = 1: unit elastic
• Confirmed error: Never write a percentage sign after PED. "PED = −0.4%" is wrong. PED = −0.4. (Jan 2020 examiner)

YED = % change in quantity demanded / % change in income

• Positive YED: normal good (income rises → demand rises)
• Negative YED: inferior good (income rises → demand falls)
• CONFIRMED MOST COMMON ERROR: Inverting the formula: YED = %ΔY / %ΔQd gives wrong answer. Always quantity on top, income on bottom. (Jan 2020 examiner: "common error was to calculate the % change in income divided by the % change in quantity demand")
• Confirmed error: "Elasticities of demand are not percentages and the % sign must not be included." (Jan 2020)

XED = % change in quantity demanded of good A / % change in price of good B

• Positive XED: substitutes (price of B rises → demand for A rises)
• Negative XED: complements (price of B rises → demand for A falls)
• Zero XED: unrelated goods
• Confirmed error: Confusing XED formula with YED formula. XED uses price of another good, not income. (Jan 2021)

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#WORKED CALCULATIONS — EVERY TYPE

PED calculation: Price of petrol rises 10%. Quantity demanded falls 4%. PED = −4% / +10% = −0.4 (inelastic) Interpretation: A 1% rise in price leads to only a 0.4% fall in quantity demanded. No % sign after the answer.

YED calculation: Income rises 5%. Quantity demanded of foreign holidays rises 15%. YED = +15% / +5% = +3 (normal good, income elastic — luxury) Interpretation: A 1% rise in income leads to a 3% rise in demand. Positive = normal good. >1 = luxury.

XED calculation: Price of butter rises 8%. Quantity demanded of margarine rises 12%. XED = +12% / +8% = +1.5 (positive = substitutes) Interpretation: 1% rise in butter price → 1.5% rise in margarine demand. Substitutes confirmed.

Percentage point vs percentage change: Unemployment rises from 4.0% to 4.5%. Percentage POINT change: 4.5 − 4.0 = 0.5 percentage points (subtraction) Percentage CHANGE: [(4.5 − 4.0)/4.0] × 100 = 12.5% (formula) From Jun 2022 examiner: "Question 8 saw many calculate the percentage point change but this needed to be explicit that this is a percentage-point change."

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#TAX INCIDENCE AND ELASTICITY

Inelastic demand (|PED| < 1): Consumer bears LARGER share of tax. Price rises significantly, quantity falls little. Tax → large price rise → consumer incidence > producer incidence. Context: cigarettes, petrol — necessities/addictive goods with inelastic demand.

Elastic demand (|PED| > 1): Producer bears LARGER share of tax. Quantity falls significantly, price rises little. Context: luxury goods — consumers switch to alternatives.

Formula for incidence (approximate): Consumer incidence = PES / (PED + PES) × tax Producer incidence = PED / (PED + PES) × tax (Signs ignored — use absolute values)

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#SIGNIFICANCE OF ELASTICITY VALUES FOR POLICY

For indirect tax on negative externality:

• Inelastic demand → tax revenue is high, but quantity reduction is small → externality correction limited
• Elastic demand → quantity reduction is large → externality correction effective, but tax revenue low Jan 2025 examiner: "The regressive nature of the taxes" and inelastic demand context both noted as evaluation points.

For minimum price:

• Inelastic demand → small surplus from minimum price → manageable government fiscal burden
• Elastic demand → large surplus → unmanageable surplus, fiscal cost very high

For subsidy on positive externality:

• Inelastic supply → price falls little, quantity rises little → subsidy achieves limited consumption increase
• Elastic supply → price falls more, quantity rises more → subsidy effectively increases consumption

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#EXAM-READY CALCULATION CHECKLIST

Before writing any elasticity answer:

□ Formula written explicitly (never skip)
□ % changes calculated correctly (numerator / denominator)
□ No % sign after the elasticity value
□ Sign interpreted: + or −, and what it means
□ Magnitude interpreted: elastic (>1), inelastic (<1), unit elastic (=1)
□ For YED: quantity ÷ income (NOT inverted)
□ For XED: Qd of A ÷ P of B (NOT inverted)

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#DIAGNOSE YOUR ELASTICITY CALCULATION

ATTEMPT 1 (YED): "YED = % change in income / % change in quantity = 5%/15% = 0.33"

Error: Inverted formula. Should be %ΔQd / %ΔY = 15/5 = 3. Common error confirmed Jan 2020.

ATTEMPT 2 (PED with % sign): "PED = −4%/10% = −0.4%"

Error: % sign after elasticity value. PED = −0.4. No percentage sign. Confirmed Jan 2020.

ATTEMPT 3 (XED interpretation): "XED = +1.5. This means the goods are inferior."

Error: XED sign indicates substitutes/complements, not normal/inferior (that's YED). Positive XED = substitutes. Negative XED = complements.

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