DEMAND ELASTICITY AND TOTAL EXPENDITURE: The notion that price-induced changes in total expenditure (price times quantity) depend on the relative price elasticity of demand. If demand is relatively elastic, then changes in price cause total expenditure to change in the opposite direction. If demand is relatively inelastic, then changes in price cause total expenditure to change in the same direction. If demand is unit elastic, then changes in price do not cause any change in total expenditure.The total expenditure that buyers make when purchasing a good depends on the price elasticity of demand. The price elasticity of demand is the relative change in quantity demanded due to a change in price. Total expenditure is price times quantity. Because price and quantity change in opposite directions along a demand curve, changes in total expenditure depend on the relative changes in price and quantity. If price changes relatively less than quantity (elastic demand), then total expenditure changes in the opposite direction of price. If price changes relatively more than quantity (inelastic demand), then total expenditure changes in the same direction of price. Five Elasticity Alternatives
Calculating Total ExpenditureConsider now a few total expenditure calculations. Total expenditure is calculated as price times quantity.
Total Expenditure and Demand
The bottom panel can be used to present the total expenditure curve derived from the demand curve. Total expenditure is found by multiplying the quantity by the corresponding price found on the demand curve. A quantity of 2 million minutes is associated with a price of 18 cents, giving a total expenditure of $180,000. A quantity of 5 million minutes is associated with a price of 10 cents and the total expenditure is $500,000. A quantity of 9 million minutes is associated with a price of 2 cents, also giving a total expenditure of $180,000. Other points on the total expenditure curve are identified in a like manner. Click the [Total Expenditure] button to reveal the curve plotted for each quantity. The result is an inverted-U shaped total expenditure curve. When quantity is zero, total expenditure is also zero, as the curve starts from the origin. As the quantity increases from 0 to 5 million minutes, total expenditure also rises. The curve peaks at 5 million minutes with a total expenditure of $500,000. The curve then declines until it reaches zero once again at a quantity of 10 million minutes. The shape of this curve is connected to the price elasticity of demand along the demand curve. Along the relatively elastic range of the demand curve, for prices between 20 and 10 cents per minute, lower prices induce greater total expenditure. Along the relatively inelastic range of the demand curve, for prices between 10 and 0 cents per minute, lower prices induce lower total expenditure. And the peak of the total expenditure curve, when total expenditure is neither rising nor falling, the demand curve is unit elastic. Click the [Five Alternatives] button to highlight this connection. What Does This Mean?An explanation for this relation rests with the fundamental concept of elasticity itself. Elasticity is the percentage change in quantity relative to the percentage change in price. Elastic demand means that the percentage change in quantity is greater than the percentage change in price. Inelastic demand means that the percentage change in quantity is less than the percentage change in price.Because total expenditure is calculated as price times quantity, any change in total expenditure results from changes in both price and quantity. As such, when a decrease in price causes the quantity to increase, then forces are working on total expenditure from both sides. The lower price works to decrease total expenditure and the larger quantity works to increase total expenditure. Which one wins? It depends on which change is greater.
Of course, there are times when sellers get this exactly backwards. Government agencies that provide price-based services, such as transportation, are often inclined to move price in the wrong direction. They mistakenly think that THE ONLY WAY to increase revenue is to raise price. However, if the good in question is relatively elastic, then a higher price causes a relatively larger decrease in quantity and a decrease in the total revenue received, not an increase. Of course, they frequently compound this error by further raising price to compensate for the lost revenue, which causes further quantity decreases and even less revenue. And then they do it again, and again, and again.... Check Out These Related Terms... | elasticity and demand slope | elasticity and supply intercept | Or For A Little Background... | elasticity | coefficient of elasticity | midpoint elasticity formula | elasticity alternatives | elasticity alternatives, demand | price elasticity of demand | elastic | inelastic | And For Further Study... | elasticity determinants | price elasticity of supply | income elasticity of demand | cross elasticity of demand | elasticity alternatives, supply | arc elasticity | monopoly, marginal revenue and demand elasticity | Recommended Citation: DEMAND ELASTICITY AND TOTAL EXPENDITURE, AmosWEB Encyclonomic WEB*pedia, http://www.AmosWEB.com, AmosWEB LLC, 2000-2024. [Accessed: May 18, 2024]. |