Allocation of Resources · 4 question types
Past paper frequency (2018 to 2024)
This topic accounts for approximately 15% of your exam marks.
PED definition, formula, calculation, and revenue application appear regularly; trending upward since 2021.
(TR) = Price × Quantity.
The same Price × Quantity figure can be read from two directions. To the firm it is total revenue (the money it takes in); to consumers it is their total expenditure (the money they spend on the good). The two are always equal, so everything that follows about a firm's revenue applies in mirror image to consumer spending: when a price change raises a firm's revenue, it raises consumer expenditure by exactly the same amount.
When a firm changes its price, two things happen at once:
Whether total revenue ends up higher or lower depends on which of the two effects is bigger, and that is exactly what PED measures.
| If demand is... | A price rise does what to TR? | A price fall does what to TR? |
|---|---|---|
| Inelastic (` | PED | < 1`) |
| Unit elastic (` | PED | = 1`) |
| Elastic (` | PED | > 1`) |
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.
PED and total revenue (a recurring MCQ and explain question)
What comes up: "Which PED value would cause total revenue to rise when the price increases?" or "Explain one advantage of producing a good with price-inelastic demand."
Write: when demand is price-inelastic (|PED| < 1), a price rise leads to a less than proportionate fall in quantity demanded, so total revenue (price × quantity) rises. When demand is price-elastic (|PED| > 1), a price rise leads to a more than proportionate fall in quantity demanded, so total revenue falls. If |PED| = 1 (unit elastic), total revenue is unchanged when price changes.
Watch out: a common slip is saying that inelastic demand means quantity demanded does not change at all — it does fall, just by a smaller percentage than the price rise. The mark scheme specifically credits the idea of a "less than proportionate" fall in quantity, not "no change." Also note: the advantage of inelastic demand is that a price rise increases revenue; the disadvantage is that a price cut reduces revenue (since quantity rises by less than the price falls).
A firm that knows its PED can pick its pricing strategy.
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.