2. Total expenditure and Price Elasticity
of Demand
There is an important relationship
between Price Elasticity of Demand and
Total Expenditure (Revenue).
def: Total expenditure (TR) = Price X
Quantity
3. Total expenditure and Price Elasticity
of Demand
• if demand is elastic, expenditure
increases as price falls ,
• if demand is inelastic,
expenditure increases as price
rises .
4. Table #1
Sample Demand Schedule
pt.
QD
TR
A
6
1
$6
B
5
2
$10
C
4
3
$12
D
3
4
$12
E
2
5
$10
F
P
6
1
$6
7. Notice the relationship between price elasticity
of demand and total expenditure:
• From B-C, the price elasticity of demand was
-9/5 (therefore, demand is elastic since the
absolute value of -9/5 is greater than 1). Also,
from B-C, total expenditure increased as price
fell.
8. • Now refer back to the table above and
see the following relationships:
• When demand is elastic, total expenditure rises
as price falls (see A-B or B-C)
• When demand is unit elastic, total expenditure
is at its maximum, and does not change when
price changes (see C-D)
• When demand is inelastic, total expenditure
rises as price rises (see E-D or F-E)
9. Price (dollars per TV)
Demand and Total Expenditure
Expenditure loss
400
elasticity = 0.6
300
200
Expenditure gain
100
Db
40
60
80
120
Quantity (millions of TVs per year)
10. Elasticity and Expenditure
• Elastic demand —
1 % price decrease
results in
more than a 1 % increase in quantity.
• Total expenditure will increase
11. Elasticity and Expenditure
• Inelastic demand —
1 % price decrease
results in
less than a 1 % increase in quantity.
• Total expenditure will decrease
12. Elasticity and Expenditure
• Unit elastic demand —
1 % price decrease
results in
a 1 % increase in quantity.
• Total expenditure does not change
14. Income Elasticity of Demand
• Normal Goods - A good is a normal good
if its income elasticity is positive. This
means that when income rises, quantity
demanded rises - most goods are normal
goods. Also, as shown below, there are
different types of normal goods:
15. Income Elasticity of Demand
• Necessity Goods - A good is a necessity if its
income elasticity is positive, but less than 1.
This means that if income rises by 10%,
quantity demanded rises by less than 10% therefore, as people's income rises, they spend
a smaller percentage of their income on
necessities.
• Luxury Goods - A good is a luxury good if its
income elasticity is positive, and greater than 1.
This means that if income rises by 10%, quantity
demanded rises by more than 10% - therefore,
people spend more of their income on luxuries
when they have larger incomes
16. Income Elasticity of Demand
• Inferior Goods - A good is an inferior
good if its income elasticity is negative.
This means that when income rises,
quantity demanded falls.
17. Cross Elasticity of Demand
Cross elasticity of demand= Percentage change in quantity demanded of
good X
Percentage change in price of good Y
Complements have negative cross elasticities.
Suplements have positive cross elasticities .
19. Determinants of Price
Elasticity of Supply
•
The ability of producers to change output - the
easier it is for producers to alter their output,
the more elastic will be the supply of a product.
•
Time Horizon - The price elasticity of supply
for most products is more elastic in the longrun than in the short-run. This is because a
longer time horizon gives producers more
opportunity to alter their output of a good.
