Elasticity and Total Expenditure

Total Expenditure: Total Expenditure on an item is Price per item times Quantity of that item demanded.
Total expenditure on an item (TE) = Price of the Unit item * Quantity of that item demanded

Example:

  • Ajay buys 35 sets of Refrigerator for his newly opened Electronics Shop. If the price of one refrigerator is Rs 20,000, calculate his total expenditure on refrigerators.
    • Total expenditure = Price of 1 refrigerator * Number of refrigerators bought
    • Total expenditure = Rs 20,000 * 35 = Rs 7,00,000 /-

Elasticity dependence of Total Expenditure:

For Elastic Demand (|PED| > 1):

  • If the demand is elastic, it means demand changes by a greater percentage than the price does. Therefore, although a unit item is purchased at a lower price, the number of items purchased becomes larger, and hence total expenditure rises.

Example:

  • Suppose a person buys 10 pens at Rs 12/pen. The price of each pen decreases by Rs 2. Consequently, a person is able to buy 20 pens. Then:
    • % change in demand = (20 - 10)/10 = 100%
    • % change in price = (10 - 12)/12 = (-)16.67%
    • Here |PED| = (100/16.67) = 6 which is greater than 1, so the item is elastic.
    • Now, Initial Total expenditure = 12*10 =Rs 120
    • & Final Total expenditure = 10*20 = Rs 200
    • As we can see, the total expenditure rises for Elastic Demand
  • For Elastic Demand, Price and Total expenditure move in opposite directions. If the price of a commodity falls, total expenditure on that commodity increases. Similarly, if the price of a commodity increases, total expenditure on that commodity decreases.
  • Price Elasticity of demand can also be calculated by the Total Expenditure Method. If TE is inversely related to the price of an item, it means that the item is Elastic (PED > 1).

Example:

  • Charu used to buy 20 chocolates in a day when the price of one chocolate was Rs 40. If the price changes to Rs 30/chocolate, she will be able to buy 30 of those. Determine whether the demand for chocolate is elastic or not.
    • Total Expenditure on Chocolate when price was Rs 40/chocolate = 20 * 40 = Rs 800
    • Total Expenditure on Chocolate when price was Rs 30/chocolate = 30 * 30 = Rs 900
    • Since Total expenditure increases as the price fall, TE and PED are inversely related. Hence, the demand for chocolate is elastic.  

For Inelastic Demand (|PED| < 1):

  • If the demand is inelastic, it means price changes by a greater percentage than the demand does. Therefore, although a unit item is purchased at a lower price, the number of items purchased becomes smaller, and hence Total Expenditure decreases.

Example:

  • Suppose a person buys 10 pens at Rs 12/pen. The price of the pen decreases by Rs 2/pen and consequently, the person is able to buy 11 pens. Then:
    • % change in demand = (11 - 10)/10 = 10%
    • % change in price = (10 - 12)/12 = (-)16.67%
    • Here |EP| = (10/16.67) = 0.6 which is lesser than 1, so the item is inelastic.
    • Now, Initial Total expenditure = 12*10 =Rs 120
    • & Final Total expenditure = 11*10 = Rs 200
    • As we can see, the total expenditure falls for Inelastic Demand.

  • For Inelastic Demand, Price and Total expenditure move in the same direction. If the price of a commodity falls, total expenditure on that commodity decreases. Similarly, if the price of a commodity increases, total expenditure on that commodity increases.
  • Price Elasticity of demand can also be calculated by the Total Expenditure Method. If TE is directly related to the price of an item. It means that the item is Inelastic (PED < 1).

Example:

  • Shagun used to buy 30 kg of rice in a month when the price of rice was Rs 30/kg. If the price changes to Rs 25/kg, she will be able to buy 32 kg of rice. Determine whether the demand for rice is elastic or not.
    • Total Expenditure on Rice when price was Rs 30/kg = 30 * 30 = Rs 900 /-
    • Total Expenditure on Rice when price was Rs 25/kg = 32 * 25 = Rs 800 /-
    • Since Total expenditure decreases as price falls, TE and PED are directly related.
    • Hence, the demand for rice is inelastic.

For Unit elastic Demand (|PED| = 1):

  • If the demand is unit elastic, change in price will cause an equal proportional change in quantity demanded. The percentage change in demand is the same as the percentage change in the price of the item, so increase/decrease in price will be compensated by an equal fall/rise in demand. Hence, Total expenditure does not change with the rise or fall in price.

Example:

  • The price of a laptop was $1000 on January 21, 2020, which increased to $2000 on February 21, 2020. This led to a decrease in sales of laptops from 5000 on January 21, 2020, to 2500 on February 21, 2020. Calculate the price elasticity of demand for laptops based on the given information. Also, determine if the demand for a laptop is unit elastic.
    • % change in demand = (2500 - 5000)/5000 = (-)50%
    • % change in price = (2000 - 1000)/1000 = 50%
    • Here |PED| = (50/50) = 1, so the item is unit elastic.
    • Now, Initial Total expenditure = 1000*5000 = Rs 50,00,000/-
    • & Final Total expenditure = 2000*2500 = Rs 50,00,000 /-
    • As we can see, the total expenditure does not change for Unit elastic Demand.

  • For Unit elastic Demand, Total expenditure does not change with rising/fall in the price of the item.
  • Price Elasticity of demand can also be calculated by the Total Expenditure Method. If TE does not change with the price of an item. It means that the item is Unit elastic (PED = 1).

Example:

  • Subhas used to buy 3 kg almonds in a month when the price of almonds was Rs 800/kg. If the price changes to Rs 1000/kg, he will be able to buy only 2.4 kg of almonds. Determine whether the demand for rice is elastic or not.
    • Total Expenditure on Rice when price was Rs 800/kg = 800 * 3 = Rs 2400 /-
    • Total Expenditure on Rice when price was Rs 1000/kg = 1000 * 2.4 = Rs 2400 /-
    • The total expenditure does not change with the price change.
    • Hence, the demand for almonds is unit elastic.

Consider the following linear demand curve:

  1. At point M, PED = 1, so Total Expenditure does not change with change in price
  2. Below point M, PED < 1, i.e. Inelastic Demand, so Total expenditure moves in the same direction as of price.
  3. Above point M, PED > 1, i.e. Elastic Demand, so Total Expenditure moves in the opposite direction as of price.
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