Price Elasticity of Demand (PED)

Total revenue (TR) = Price × Quantity.

When a firm changes its price, two things happen at once:

• Price goes up (or down): that pushes TR up (or down).
• Quantity demanded goes down (or up): that pulls TR in the opposite direction.

Whether total revenue ends up higher or lower depends on which of the two effects is bigger, and that is exactly what PED measures.

The PED-TR rule

The simplest way to memorise it: price and TR move in the same direction when demand is inelastic; in opposite directions when demand is elastic.

Example — A restaurant chain raises the price of its signature burger from £8 to £9.20, expecting a small drop in sales. Sales fall from 1,000 burgers per day to 940. Did the price rise raise or lower revenue?

• %ΔP = (9.20 − 8.00) ÷ 8.00 × 100 = +15 %
• %ΔQd = (940 − 1,000) ÷ 1,000 × 100 = −6 %
• |PED| = 6 ÷ 15 = 0.4 → demand is inelastic.

Revenue check:

• Old TR = £8.00 × 1,000 = £8,000
• New TR = £9.20 × 940 = £8,648

TR rises by £648 a day. Because demand is inelastic, the price rise was the right move for revenue: the small fall in sales was outweighed by the much larger price increase.

What firms should do

A firm that knows its PED can pick its pricing strategy.

• Selling an inelastic good? Raise the price. The fall in quantity sold is smaller than the rise in price, so TR rises.
• Selling an elastic good? Cut the price. The rise in quantity sold is larger than the fall in price, so TR rises.

A common follow-up technique is price discrimination: charging different prices to different groups (peak vs off-peak, student vs adult, business vs leisure airfare). The firm raises prices to inelastic groups and lowers prices to elastic groups to maximise total revenue.