26

Price elasticity of
demand 10
OVERVIEW

We are still on our journey investigating how a society can deal with the economic problem of scarce
resources and unlimited needs and wants.
This scarcity problem forces us to make choices, and every choice we make has a cost – the
opportunity cost – which is the best alternative we give up by making this choice. We have seen that
because of this scarcity problem, every society needs to answer the following three fundamental
questions:
 What should be produced?
 How should it be produced?
 For whom should it be produced?

We have identified the market system as a possible way to deal with these questions, and indicated that
in a market system it is the price mechanism that helps society to deal with these fundamental
questions. To explain how the price mechanism operates, we have developed a model – the demand
and supply model.
In this model, we have shown how the price of a good or service is determined by the interaction
between the forces of demand and supply. We have explained demand with the aid of a demand curve
and supply with the aid of a supply curve, and indicated how the equilibrium price and quantity are
formed in the market.

Excess supply Excess demand

With this model, we have shown that prices have a signalling and rationing function in that they rise
and fall to indicate excess demand (shortage) and excess supply (surplus), and how through price
changes, this excess demand or excess supply is eliminated.
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For instance, if households have a higher demand for goods and services, the demand for these goods
and services increases. An excess demand is thus created, which causes the price to rise and the
quantity demanded and supplied to adjust. A signal has thus been sent from the households to the
producers.

Increase in demand

However, if there is a decrease in the supply of a good or service, the supply from producers' decreases.
An excess demand is thus created, which causes the price to rise and the quantity demanded and
supplied to adjust. A signal has therefore been sent from producers to households.

Decrease in supply

In this topic called price elasticity, we will take a closer look at the demand for a good or service by
investigating the relationship between a change in price and the change in quantity demanded.
This will give us a better understanding of how households and firms are influenced by a change in the
price of a good or service.
Read through the following extract and reflect on the questions asked:

The price elasticity of demand is defined as “the percentage change in the quantity demanded
divided by the corresponding percentage change in its price” (Begg 2000). The application of this
theory to the retail fuel industry proposes that an increase in the fuel price leads to a reduction in
the demand for fuel. Considerable research has attempted to identify factors that influence fuel
demand, as well as to provide insights into the sensitivity of consumer demand to fuel prices
changes (Espey 1996). Fuel price has been identified as one of the key variables affecting the
demand for fuel (Graham & Glaister 2002). However, South African consumers have indicated a
relatively inelastic short-term demand for fuel because of a lack of alternative transport systems.
It could be expected, however, that higher levels of elasticity could be achieved through a
 28
combination of a reduction in the use of vehicles, lift clubs, the use of public transport, better
driving techniques, more regular servicing of vehicles and a shift to more fuel-efficient vehicles
in the longer term (TDM Encyclopedia 2005a; 2005b). In this regard, Graham and Glaister
(2002) also highlight the impact of a better infrastructure and a functional public transport system
on fuel demand.
Graham and Glaister (2002) performed an extensive international survey on the response of
motorists to fuel price changes that indicated a fairly narrow range for short-term price elasticity
and a bigger range for long-term price elasticity. This research concluded that, in general,
international short-term price elasticity ranged between –0,10 and –0,3 and long-term price
elasticity between –0,6 and –0,8. The price elasticity of gasoline in the USA, for instance, was
estimated to be –0,15 in the short run and –0,6 in the long run (Bailly 1999). In South Africa, the
Bureau for Economic Research (2003) estimated that the short- and long-term price elasticity of
demand for petrol ranged between –0,21 and –0,51, respectively. All of these results indicate
short-term inelastic conditions that become more responsive over time.
In this regard, short-term inelasticity with respect to petrol in South Africa is illustrated by a 17%
increase in the petrol price in 2005, which only resulted in a 0,2% drop in sales …
Source: Sartorius, K., Eitzen, C & Hart, J. 2007. An examination of the variables influencing
the fuel retail industry. Retrieved from
https://actacommercii.co.za/index.php/acta/article/download/33/32

Questions for reflection

1. Are South African consumers sensitive or insensitive to a change in the price of fuel?
2. What do South African consumers do if the price of fuel increases?
3. Why is it not possible for South African consumers to adjust their use of fuel in the short run?
4. What happens to the revenue of fuel supplier if the price of fuel increases and what happens to
their revenue if the price of fuel decreases?

TOPIC OUTCOME

After you have worked through this learning unit, you should be able to:
• explain and illustrate the concept price elasticity and the relationship between price elasticity
and total revenue

10.1 What do we do when prices increase?

How we react depends to a large degree on what kind of good or service it is and by how much the
price increases.
In the past, an increase in the price of bread in Iran has caused massive protests, an increase in public
transport fares in Brazil led to violent protests, and in South Africa a rise in the price of petrol usually
leads to strong verbal protests from motorists and taxi commuters.

Which one of the following would upset you the most?

o An increase in the price of petrol
o An increase in the price of ice cream
Most people will be more upset if the price of petrol rises than if the price of ice cream rises.
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Think for a moment why people are more upset if the price of petrol rises than if the price of ice
cream rises. Is it because …
o it is the government's fault the price of petrol rises.
o it is extremely difficult for people to decrease the quantity of petrol they use.
o it is easier to decrease the quantity of ice cream bought than the quantity of petrol bought.
Yes, it is easier to eat less ice cream than to use less petrol. As the price of petrol increases, it is
very difficult to decrease the quantity of petrol we demand. That is probably why we get more
upset if the price of petrol rises than if the price of ice cream rises.

To get a better understanding of how households and firms react, and how they are influenced by price
changes, we need to unpack the concept of "price elasticity", which is what we will start doing in the
next section.

10.2 Description of price elasticity of demand

After you have worked through this section of the learning unit, you should be able to:

• describe the concept price elasticity of demand with the aid of a demand curve

Before we give a description of the concept of price elasticity, we need to recap what we have learned
about the law of demand, since the concept of price elasticity is closely related to the law of demand.
From the law of demand we know that if the price changes, the quantity demanded changes. According
to this law, an increase in price will decrease the quantity demanded, and a decrease in price will
increase the quantity demanded.
Study the following diagram and make sure you know what happens if the price changes.

o What happens to the quantity demanded if the price increases from P3 to P4?
o What happens to the quantity demanded if the price decreases from P4 to P2?

If the price increases from P3 to P4, the quantity demanded decreases, since an inverse relationship
exists between the price and the quantity demanded. The decrease is from Q3 to Q2.

If the price decreases from P4 to P2, the quantity demanded increases, since an inverse relationship
exists between the price and the quantity demanded. The increase is from Q2 to Q4.
 30
From the law of demand, we know that if the price of a good or service increases, the quantity
demanded will decrease; and if the price decreases, the quantity demanded increases.

The question we are dealing with is:

By how much would the quantity demanded change if the price were to change? In other words, we
wish to measure the impact of a change in the price on the quantity demanded.
It is the concept of price elasticity of demand that gives us a measure of how sensitive or
responsive the quantity demanded is to a change in the price of a good or service.
Here we are moving from theoretical economics to empirical economics. When we dealt with the
theory of demand, supply and prices, we simply indicated the direction of change. We argued that if,
say, the supply of a good or service increases, the price decreases, which increases the quantity
demanded.
In empirical economics, we want to measure by how much the price decreases and by how much the
quantity demanded increases.
In the following diagram, we can see that an increase in supply will decrease the price from R4 to R2
and, in turn, will increase the quantity demanded from 500 to 600.

Price elasticity

We now have a basis to measure how sensitive or responsive the quantity demanded is to a change in
the price. In other words, we can measure the price elasticity of demand.
∆𝑃𝑃 → ∆𝑄𝑄𝑑𝑑

R4 to R2 →500 to 600

The topic of the next section is how to measure price elasticity on the basis of the data provided.
Before you continue to the section on the measurement of price elasticity, do the following activity to
make sure that you grasp the meaning of the concept of price elasticity.
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ACTIVITY 1

1.1 Indicate whether the following statements relating to price elasticity of demand is true or false:

T F

a. The price elasticity of demand provides us with a measure of how sensitive or

responsive the price of a good or service is to a change in demand.

b. If you know what the price elasticity of petrol is, you will know how sensitive
or responsive the quantity demanded of petrol is to a change in the price of
petrol.

c. If you know what the price elasticity of petrol is, all you will be able to say is
that an increase in the price of petrol will reduce the quantity of petrol
demanded.

d. If you know what the price elasticity of petrol is, you will be able to predict what
happens to the price of petrol if the demand for petrol changes.

e. If the price elasticity of ice cream is greater than the price elasticity of petrol, it
means that households are more responsive or sensitive to a change in the price
of ice cream than to a change in the price of petrol.

f. People become more upset about an increase in the price of petrol compared to
an increase in the price of ice cream. This implies that they are more responsive
or sensitive to a change in the price of petrol than a change in the price of ice
cream.

g. If a business knows what the price elasticity of demand for its product is, it will
be able to predict what will happen to its sales if the price of the product changes.

h. If a supplier of fresh tomatoes knows what the price elasticity of fresh tomatoes
is, the supplier will be able to predict what will happen to his or her total revenue
from the sale of fresh tomatoes if the price of fresh tomatoes changes
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1.2. Study the diagrams below. Which diagram represents what we are going to measure through
price elasticity?
a.

b.

10.3 Measurement of price elasticity of demand

After you have worked through this section of the learning unit, you should be able to:

• describe the measurement of price elasticity

• calculate the price elasticity coefficient using the midpoint method
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Let's start with a question:
You are given the following information:
The price of a good or service increases by R5, while the quantity demanded decreases by 1 000.
Would you say that the price increase is:
o Big
o Small
o Need more information to make a judgment.

Would you say that the decrease in the quantity demanded is:
o Big
o Small
o Need more information to make a judgment.

We need more information than only the absolute changes (i.e. R5 and 1 000). Unless we know
what the basis is on which these changes have taken place, we cannot say whether it is big or
small. We need to determine the relative changes in order to answer the question. In other words,
we need to know the percentage change in price and quantity before we can make a judgement.
Let's see what happens when we know what the percentage changes are. In each of the questions
below, select the best answer.
You are provided with the following information:
The price of a good increases by R5, which is a 100% increase in the price, while the quantity
demanded decreases by 1 000, which is a 1% decrease in quantity demanded.
Would you say that the price increase is:
o Big
o Small
o Need more information to make a judgment.

Would you say that the decrease in the quantity demanded is:
o Big
o Small
o Need more information to make a judgment.

There is no doubt that the increase in the price is big (100%), while the decrease in quantity
demanded is small (1%). We are now working with relative changes, and are thus in a position to
make a judgement.
Here, we can say that a big change in price leads to a small change in the quantity demanded, and
we can in effect calculate the price elasticity coefficient on the basis of this information.

Once we know these percentages changes, it is possible to measure price elasticity through the price
elasticity coefficient.
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The price elasticity coefficient

The price elasticity coefficient gives us a measure of how sensitive or responsive the quantity
demanded of a good or service is to a change in the price of the good or service. It is our
measure of price elasticity.
If we know what the percentage change in price and the percentage change in quantity demanded are,
we can calculate the price elasticity coefficient by using the following formula:
% 𝑐𝑐ℎ𝑎𝑎𝑎𝑎𝑎𝑎𝑎𝑎 𝑖𝑖𝑖𝑖 𝑞𝑞𝑞𝑞𝑞𝑞𝑞𝑞𝑞𝑞𝑞𝑞𝑞𝑞𝑞𝑞 𝑑𝑑𝑑𝑑𝑚𝑚𝑎𝑎𝑎𝑎𝑎𝑎𝑎𝑎𝑎𝑎
𝑃𝑃𝑃𝑃𝑃𝑃𝑃𝑃𝑃𝑃 𝑒𝑒𝑒𝑒𝑒𝑒𝑒𝑒𝑒𝑒𝑒𝑒𝑒𝑒𝑒𝑒𝑒𝑒𝑒𝑒 =
% 𝑐𝑐ℎ𝑎𝑎𝑎𝑎𝑎𝑎𝑎𝑎 𝑖𝑖𝑖𝑖 𝑝𝑝𝑝𝑝𝑝𝑝𝑝𝑝𝑝𝑝

Using symbols, this is written as follows:

%∆𝑄𝑄𝑑𝑑
𝑒𝑒𝑝𝑝 =
%∆𝑃𝑃
Using the data in our example, where the price increases by 100% and the quantity demanded decreases
by 1%, the price elasticity coefficient for the good is:
1%
𝑒𝑒𝑝𝑝 = = 0,01
100%
Should the answer not be –0,01? It should indeed. Since the quantity demanded decreases, it should be
reflected as –1%, and the answer should therefore be –0,01. Economists usually ignore the negative
sign, and report the elasticity coefficient as a positive value (in mathematics, this is called absolute
values). One of the reasons for this is that we know that the law of demand indicates a negative
relationship between the price and quantity demanded and, consequently, the value of the price
elasticity coefficient will always be negative. Nothing is lost by using the absolute values as long as we
remember that we are dealing with an inverse relationship.
Thus far it all seems to be straightforward. Obtain the percentage changes, and then calculate the price
elasticity using the formula. And it is indeed that simple, except that we need to deal with how the
percentage changes are to be calculated.
Calculate percentage change in price and percentage change in quantity demanded
You have the following information:

Price (P) Quantity demanded (Qd)

8 100
10 90

If the price increases from R8 to R10, what is the percentage increase in price?
What is the percentage decrease in quantity demanded if the price increases from R8 to R10?
What is the price elasticity coefficient, using the answers to the above questions?
The increase in price is R2, and the percentage increase in price is R2/R8 x 100 = 25%. The quantity
demanded decreases by 10 units (100 – 90), and the percentage decrease in the quantity demand is 10
units/100 units = 10%. In this case, the price elasticity coefficient is:
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%∆𝑄𝑄𝑑𝑑
𝑒𝑒𝑝𝑝 =
%∆𝑃𝑃
10%
=
25%
= 0,4

If you do the same exercise, but assume that the price decreases from R10 to R8, will you obtain the
same price elasticity coefficient as in the previous example that used an increase in the price from R8
to R10?
Do the calculations to see what your answer would be.
If you did the calculations correctly, you will see that the percentage change in price is R2/R10 x 100 =
20%, and the percentage change in quantity demanded is 10 units/90 units x 100 = 11,1%. In this
example, the price elasticity coefficient is:
%∆𝑄𝑄𝑑𝑑
𝑒𝑒𝑝𝑝 =
%∆𝑃𝑃
11%
=
20%
= 0,55

The reason for this difference is that it depends on the starting point (the value we use as the basis for
our calculations). It the starting value for price is R8, a R2 increase in price implies a 25% increase in
the price. If the starting value for price is R10, a R2 decrease in price implies a 20% decrease in price.
The same happens for the change in quantity demanded.
What we are looking for is a measure that is independent of the starting point or direction of change. A
R2 increase in the price should give us the same answer as a R2 decrease in price.
To solve this problem, we make use of the midpoint method to calculate the price elasticity coefficient.

Arch elasticity: Midpoint method

When price elasticity is calculated using two points, it is known as arch elasticity. The midpoint
method involves using the average of the initial and ending values.
Let's use our previous example, where:

Price (P) Quantity demanded (Qd)

8 100
10 90
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The calculation of price elasticity using the midpoint method involves the following:

Step 1: Calculate the midpoints for P and (Qd)

(8 + 10) (90 + 100)
Midpoint of 𝑃𝑃 = Midpoint of 𝑄𝑄 =
2 2
=9 = 95

Step 2: Calculate the percentage change in P and Qd if price increases from R8 to R10.
(10 − 8) (90 − 100)
%∆𝑃𝑃 = × 100 %∆𝑄𝑄𝑑𝑑 = × 100
9 95
2 10
= × 100 = × 100
9 95
= 22,2% = 10,5%

Step 3: Use the formula for price elasticity to calculate the price elasticity coefficient

%∆𝑄𝑄𝑑𝑑
𝑒𝑒𝑝𝑝 =
%∆𝑃𝑃
10,5%
=
22,2%
= 0,47

Assuming that the price decreases from R10 to R8 will give the same result as an increase from R8 to
R10, we have eliminated the "increase versus decrease" issue.
If we add all the above steps together, we end up with the following formula for calculating arch
elasticity:
(𝑄𝑄2 − 𝑄𝑄1 )
𝑄𝑄1 + 𝑄𝑄2
𝑒𝑒𝑝𝑝 = 2
(𝑃𝑃2 − 𝑃𝑃1 )
𝑃𝑃1 + 𝑃𝑃2
2
This looks rather intimidating, but it is nothing more than a combination of the various steps. The (Q2 –
Q1) is the difference between the end value and the initial value of the quantity demanded (90 – 100).
The [(Q1 + Q2 )/2] is the midpoint value for the quantity demanded [(100 + 90)/2]. The (P2 – P1) is the
difference between the end value and initial value for the price (R10 – R8).
The [(P1 + P2 )/2] is the midpoint value for the price [(R8 + R10)/2]. We have left out the multiplication
by 100 since it occurs above and below the line, which means that each cancels out the other.
The (Q2 – Q1 )/ [(Q1 + Q2 )/2] gives us the percentage change in quantity demanded
(10,5%) while (P2 – P1 )/[(P1 + P2 )/2] gives us the percentage change in price (22,2%).
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We can even further simplify the formula by getting rid of the 2 since it occurs above and below the
line, and end up with the following formula for arch elasticity using the midpoint method:
𝑄𝑄2 − 𝑄𝑄1
𝑄𝑄 + 𝑄𝑄2
𝑒𝑒𝑝𝑝 = 1
𝑃𝑃2 − 𝑃𝑃1
𝑃𝑃1 + 𝑃𝑃2

Using the data in our example, the arch elasticity can be calculated as follows:
(90 − 100)
(100 + 90)
𝑒𝑒𝑝𝑝 =
(10 − 8)
(8 + 10)
10
= 190
2
18
0,052
=
0,111
= 0,47
This price elasticity coefficient of 0,47 is the ratio between the percentage change in price and the
percentage change in quantity demanded, and tells us that a 1% increase in price will cause a 0,47%
decrease in quantity demanded, and that a 1% decrease in price will cause a 0,47% increase in quantity
demanded.
Do the following activity about the calculation of price elasticity of demand.

ACTIVITY 2

The following diagram shows what happens if the supply of say, restaurant meals, decreases because of
an increase in the cost of producing restaurant meals. The equilibrium price increases and the
equilibrium quantity declines. What you need to do is to calculate the price elasticity coefficient for
restaurant meals for the price increase range R100 to R110.
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10.4 Types of price elasticity

After you have worked through this section of the learning unit, you should be able to:

• describe and differentiate between the different types of price elasticities

Now that we know how price elasticity is calculated by dividing the percentage change in quantity
demanded by the percentage change in price, we need to interpret different price elasticity coefficients.
If you look at the table below, which gives you the price elasticities of demand for various goods and
services, you will notice that the price elasticity ranges from 0,1 for salt to 4,68 for fresh tomatoes.
Different price elasticities

Goods and Price elasticity Goods and services Price elasticity

services coefficient coefficient
Salt 0,1 Tyres 0,9
Matches 0,1 Shoes 0,91
Electricity 0,13 Private education 0,1
(Households)
Coffee 0,25 Motor vehicles 0,14
Medical care 0,31 Beef 1,27
Tobacco products 0,45 Restaurant meals 2,27
Fuel (petrol) 0,6 Lamb and mutton 2,65
Beer 0,9 Fresh tomatoes 4,6
Source: Janse van Rensburg, J., Mconnel, C.R. & Brue, S.L. 2015. Economics. McGraw Hill:
London.
What is the meaning of the difference between a price elasticity of 0,1 for salt and 4,6 for fresh
tomatoes? Is this difference important?
An important difference is that a price elasticity of 0,1 for salt indicates that a 1% change in the price of
salt will cause a 0,1% change in the quantity demanded, while a price elasticity of 4,6 for fresh
tomatoes indicates that a 1% change in price will cause a 4,6% change in the quantity demanded.
Based on this, we can say that in the case of salt, a change in the price has a smaller effect on the
quantity demanded, and consumers are less responsive (sensitive) to a change in the price of salt
compared to a change in the price of fresh tomatoes.
Another difference is that in the case of salt, the price elasticity is less than 1, while for fresh tomatoes,
the price elasticity is greater than 1.
In fact, if you look at the table again, you will notice that goods and services can be classified as having
a price elasticity of less than 1 or more than 1.
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Let's look at our formula for price elasticity:
%∆𝑄𝑄𝑑𝑑
𝑒𝑒𝑝𝑝 =
%∆𝑃𝑃
When the percentage change in price is greater than the percentage change in quantity demanded, the
price elasticity will be less than 1. If the percentage change in price is smaller than the percentage
change in quantity demanded, the price elasticity will be greater than 1.
As a general rule, we can state the following:

• If the percentage change in price is greater than the percentage change in quantity demanded,
then the price elasticity coefficient is less than 1. This applies to things such as salt, medical
services, fuel, beer and so forth. In these cases consumers are less responsive or sensitive to a
change in the price.

• If the percentage change in price is smaller than the percentage change in quantity demanded,
then the price elasticity coefficient is greater than 1. This applies to things such as private
education, restaurant meals and fresh tomatoes. In these cases consumers are more responsive
or sensitive to a change in price.

What we will identify and describe in the rest of this section are the different types of elasticity. These
are based on the varying impact of a change in price on the quantity demanded, as measured by the
price elasticity coefficient.
Do the following activity about the price elasticity coefficient.

ACTIVITY 3

3.1 You are given the following information:

Goods and services Price elasticity

coefficient
Private education 1,1
Electricity (Households) 0,13
Restaurant meals 2,27
Fuel (petrol) 0,6

a. Indicate for which goods and services is the % change in price greater than the % change in
quantity demanded and for which is the % change in price smaller than the % change in
quantity demanded.
b. Compare the price elasticity of electricity with restaurant meals and indicate whether
consumers are more responsive (sensitive) or less responsive (sensitive) to a change in the
price of electricity compared to a change in the price of restaurant meals.
 40
3.2 If the % change P is greater than the % change in Qd, then the price elasticity coefficient is … .
a. smaller than 1
b. greater than 1
c. equal to 1

Relatively inelastic demand

The first type of elasticity we take a closer look at is known as a relatively inelastic demand.
In the case of a relatively inelastic demand, the percentage change in price is greater than the
percentage change in quantity demanded. And when the percentage change in price is greater than the
percentage change in quantity demanded, the price elasticity coefficient will have a value of less than 1.
In other words:
If ep < 1, we have a relatively inelastic demand.

In the price elasticity table, goods and services with a relatively inelastic demand are things such as
salt, medical care, tobacco products and petrol (fuel). They all have an elasticity coefficient of less than
1. What this means is that the quantity demanded is not highly sensitive to a change in the price.
Different price elasticities

Goods and services Price elasticity Goods and services Price elasticity
coefficient coefficient
Salt 0,1 Tyres 0,9
Matches 0,1 Shoes 0,91
Electricity 0,13 Private education 0,1
(Households)
Coffee 0,25 Motor vehicles 0,14
Medical care 0,31 Beef 1,27
Tobacco products 0,45 Restaurant meals 2,27
Fuel (petrol) 0,6 Lamb and mutton 2,65
Beer 0,9 Fresh tomatoes 4,6
Source: Source: Janse van Rensburg, J., Mconnel, C.R. & Brue, S.L. 2015. Economics.
McGraw Hill: London.
On the basis of this, we can argue that people are relatively unresponsive or insensitive to adjusting
their quantity demanded if the price changes. Note that unresponsive and insensitive in this sense
means that people find it difficult to change their quantity demanded of the good, and not that they do
not become upset if the price changes.
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In the case of fuel (petrol), which has a price elasticity of 0,6 in the table, this implies that a 10% rise in
the price of fuel will reduce the quantity demanded by 6% – which is less than the percentage change in
price. This is referred to as a relatively inelastic demand.
Graphically, we can illustrate a relatively inelastic demand as follows:
Inelastic demand: % change in price > % change in quantity demanded and ep <= 1

Relatively inelastic demand

Examples are: salt, coffee, medical care and beer.
A 10,5% increase in price reduces the quantity demanded by 5,1%. The lower the price elasticity of
demand, the steeper the demand curve will be.

Relatively elastic demand

Where the percentage change in price is smaller than the percentage change in quantity demanded, we
have a relatively elastic demand. Whenever the percentage change in price is smaller than the
percentage change in quantity demanded, the price elasticity coefficient will have a value of more than
1.
In other words:

• If ep > 1, we have a relatively elastic demand.

In our table, goods and services with a relatively elastic demand are things such as private education,
motor vehicles, restaurant meals and fresh tomatoes. They all have an elasticity coefficient of more
than 1. What this means is that the quantity demanded is extremely sensitive to a change in the price.
On the basis of this, we can argue that people are relatively responsive or sensitive to adjusting their
quantity demanded if the price changes. In the case of private education, which has a price elasticity of
1,1, this implies that a 10% rise in the price of private education will decrease the quantity demanded
by 11% – the percentage change in price is less than the percentage change in quantity demanded. This
is then referred to as a relatively elastic demand.
 42
Graphically, a relative elastic demand can be represented as follows:

Relatively elastic demand

Examples are: private education, beef and fresh tomatoes.
A 10,5% increase in price decreases the quantity demanded by 29%. The higher the price elasticity of
demand, the flatter the demand curve will be in the particular price range.

Unitary elasticity
Where the percentage change in price is equal to the percentage change in quantity demanded, the price
elasticity coefficient is equal to 1. In other words, a 1% increase in price leads to a 1% decrease in
quantity demanded, giving us a price elasticity coefficient of 1. This is called unitary elasticity.
In other words:

• If ep = 1, we have a unitary elastic demand.

If you examine the table, you can see that shoes are close to unitary elasticity. Most goods and services
in the table, however, either have an elasticity of less than 1 or more than 1.
Graphically, it can be represented as follows:

Unitary elasticity
A 10,5% increase in price decreases the quantity demanded by 10,5%.
 43 ECS1501/002

Some extreme cases

Thus far we have identified three types of elasticity, namely relatively price inelastic (ep <1), unitary
elastic (ep= 1) and relatively elastic (ep >1). There are two other interesting theoretical types, namely
perfectly inelastic and perfectly elastic.

Perfectly inelastic demand

A perfectly inelastic demand curve occurs when a change in price does not have any impact on the
quantity demanded.
In terms of our formula, the percentage change in quantity demanded is equal to 0.
0
𝑒𝑒𝑝𝑝 =
%∆𝑃𝑃
Here the price elasticity coefficient is equal to zero since the percentage change in quantity demanded
is 0, and when you divide 0 by any value, the answer is still 0.
This kind of elasticity might occur when people are highly addicted to some kind of drug or need life-
saving medication.

Perfectly inelastic demand

A 10,5% increase in price does not have an impact on the quantity demanded.

Perfectly elastic demand

A perfectly elastic demand curve occurs when a small change in price has a major impact on the
quantity demanded. Here, a small percentage change in price causes a percentage change in the
quantity demanded that approaches infinity.

𝑒𝑒𝑝𝑝 = ∞
 44
Graphically, it can be represented as follows:

Perfectly elastic demand

Do the following activity about the different types of elasticity.

ACTIVITY 4

4.1 If the % change in P is greater than the % change in Qd, then demand is …
a relatively inelastic.
b relatively elastic.
c unitary elastic.
4.2 A relatively elastic demand implies that …
a the % change in price is greater than the % change in Qd.
b the % change in price is smaller than the % change in Qd.
c the % change in price is equal to the % change in Qd.
4.3 A relative elastic demand implies that the price elasticity coefficient is …
a smaller than 1.
b greater than 1.
c equal to 1.
4.4 If a 12% change in P leads to a 6% change in Qd, the demand is ...
a relatively inelastic
b relatively elastic
c unitary elastic
4.5 If a 8% change in price leads to a 12% change in Qd, the demand is …
a relatively inelastic
b relatively elastic
c unitary elastic
4.6 Given the following information about the price elasticity of a good or service, select the
appropriate price elasticity characteristics for this product from the different categories.
 45 ECS1501/002
An increase of 9% in the price of the product decreases the quantity demanded by 5%.

o Relatively inelastic
o Relatively elastic
o Unitary elastic
o Perfectly inelastic
o Perfectly elastic
o ep = 1
Categories o 0 < ep < 1
o 1 < ep < ∞
o ep = 0
o ep = ∞
o It has a relatively low price elasticity value.
o It has a relatively large price elasticity value.
o It has a unitary price elasticity value.

4.7 Given the following information about the price elasticity of a good or service, select the
appropriate price elasticity characteristics for this product from the different categories.
The product has a price elasticity of 1.7.

o Relatively inelastic
o Relatively elastic
o Unitary elastic
o ep = 1
o 0 < ep < 1
o 1 < ep < ∞
o It has a relatively low price elasticity value.
o It has a relatively large price elasticity value.
Categories
o It has a unitary price elasticity value.
o The % change in Qd is less than the % change in P.
o The % change in Qd is greater than the % change in P.
o The % change in Qd is equal to the % change in P.
o It can be argued that for this product people are not very
price sensitive.
o It can be argued that for this product people are price
sensitive.

4.8 Assume that due to an improvement in the weather, the maize crop increases. The equilibrium
price decreases from R1 000 per ton to R850 per ton while the equilibrium quantity increases
from 1 million tons to 1,1 million tons.
 46
Select the appropriate price elasticity characteristics for maize.

o Relatively inelastic
o Relatively elastic
o Unitary elastic
o Perfectly inelastic
o Perfectly elastic
o ep = 1
o 0 < ep < 1
o 1 < ep < ∞
o ep = 0
o ep = ∞
o It has a relatively low price elasticity value.
Categories
o It has a relatively large price elasticity value.
o It has a unitary price elasticity value.
o The % change in Qd is less than the % change in P.
o The % change in Qd is greater than the % change in P.
o The % change in Qd is equal to the % change in P.
o The % change in Qd is 0.
o The % change in Qd is infinite.
o It can be argued that for this product people are not very
price sensitive.
o It can be argued that for this product people are price
sensitive.

4.9 You are given the following diagrams and must indicate whether the demand is relatively elastic,
relatively inelastic or unitary elastic.
a.
 47 ECS1501/002
b.

c.

10.5 Elasticity along a linear demand curve

Study the following linear demand curve and decide whether it is relatively elastic, relatively
inelastic, unitary elastic, or all of them:

It all depends on which part of the demand curve (price ranges) we are referring to. By just looking
at it, we cannot tell whether it is relatively elastic, relatively inelastic or unitary elastic. In fact,
depending on which part of the linear demand curve you are looking at, it could be all three of
these – relatively inelastic, relatively elastic or unitary elastic.
 48
Let's see why this is so.

Elasticity along a linear demand curve

If you calculate the midpoint elasticity when the price declines from R8 to R7, you will obtain an
elasticity of 5 (relatively elastic). In this high price range and low quantity range, the percentage change
in price is low (R8 to R7), while the percentage in quantity is high (10 to 20).
Calculating the midpoint elasticity for a change in price from R5 to R4 will give you a price elasticity
of 1 (unitary elasticity).
For a change in price from R2 to R1, you will obtain a price elasticity of 0,20 (relatively inelastic). In
this low price range and high quantity range, the percentage change in price is high (R2 to R1), while
the percentage in quantity is low (70 to 80).
Examine the data, not the graph, to decide whether demand is relatively inelastic, unitary elastic or
relatively elastic.
Take note of the following:
Price elasticity of demand gives us a measure of the response of the quantity demanded to a change in
the price. It is therefore closely related to (but not the same as) the slope of the demand curve. The
slope of the demand curve is calculated from absolute changes in quantity and price, while price
elasticity is calculated from relative changes.
As a rule of thumb, we can state that if we use the same scale on the axis, the flatter the curve that
passes through a given point, the greater the price elasticity of demand will be, and the steeper the
curve that passes through a given point, the smaller the price elasticity of demand will be.

10.6 Factors that have an impact on price elasticity

After you have worked through this section of the learning unit, you should be able to:

• describe the impact that factors such as availability of substitutes, proportion of income spend,
time period and nature of the product have on price elasticity

Looking again at our table of price elasticity for various goods and services, we are now able to classify
these according to relatively price inelastic and relatively price elastic. What we do not know yet is
what causes different goods and services to have different price elasticities.
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Different price elasticity coefficients

Goods and Price elasticity Goods and services Price elasticity

services coefficient coefficient
Salt 0,1 Tyres 0,9
Matches 0,1 Shoes 0,91
Electricity 0,13 Private education 0,1
(Households)
Coffee 0,25 Motor vehicles 0,14
Medical care 0,31 Beef 1,27
Tobacco products 0,45 Restaurant meals 2,27
Fuel (petrol) 0,6 Lamb and mutton 2,65
Beer 0,9 Fresh tomatoes 4,6
Source: Source: Janse van Rensburg, J., Mconnel, C.R. & Brue, S.L. 2015. Economics.
McGraw Hill: London.
Why, for instance, is fuel relatively price inelastic, and restaurant meals relatively price elastic?
This might be due to the following factors:
 availability of substitutes
 proportion of income spend
 time period
 nature of the product

Availability of substitutes
Consider the following scenario:
Peter lives 25 kilometres from his work and owns a small car powered by petrol, which he uses to
travel to work. There is no public transport in the area in which he lives.
If the price of petrol increases by 10% on Wednesday, will Peter be able to decrease his quantity of
petrol by making use of a substitute?
Unfortunately for Peter, there is no substitute for petrol and he cannot make use of public transport
because there is none where he lives. He will therefore not be able to decrease his quantity of petrol
demanded by much. His demand for petrol is price inelastic, owing to the absence of substitutes. This
absence or non-availability of substitutes is therefore an important determinant of the price elasticity of
petrol for Peter.
However, bear in mind that the more substitutes there are, the more choices you have and the greater
the price elasticity of the good or service will be.
Take the example of a restaurant meal where there is a number of substitutes available, such as a home-
cooked meal, a take-away, and a pre-cooked meal from Shoprite or Woolworths. If the price of a
restaurant meal increases, you can always switch to one of the substitutes.
 50
As you use more of a substitute, the quantity demanded of the other good decreases.
As a general rule, we can state the following:
The more substitutes there are for a good or service, the more responsive or sensitive the quantity
demanded will be to a change in the price. The price elasticity of quantity demanded is therefore
higher and more elastic.

The fewer substitutes there are, the less responsive or sensitive the quantity demanded for a
change in price will be. The price elasticity of quantity demanded is therefore lower and demand
is more price inelastic.

Proportion of income spent

The last time I checked, a box of matches costs about 70 cents. If I buy four boxes of matches a month,
my total spending on matches will be R2,80. An increase in the price of matches to 77 cents, which is a
10% increase, would not make me change my behaviour.
Likewise, a 10% decline in the price of matches would also not make me buy more matches. So my
price elasticity for matches is relatively inelastic (it has a value of less than 1).
 51 ECS1501/002

The reason for this is not that there are no substitutes available (I could, for example, buy a lighter), but
because the R2,80 is an insignificant proportion of my income. Whether I spend R2,80 or R3,08 per
month on matches is not a big deal for me.
However, if it is about buying something like a new fridge, which costs about R4 500 and is a large
proportion of my income, a 10% rise in the price of the fridge would make me reconsider buying it.
Whether I spend R4 500 or R4 950 is important to me, and it is to be expected that my price elasticity
for a fridge would be fairly elastic (has a value of more than 1).

In general, we can state the following:

The higher the proportion of income spent on a good and service, the more responsive or
sensitive the quantity demanded will be to a change in the price. The price elasticity of quantity
demanded is therefore higher and more elastic. The lower the proportion of income spent on a
good or service, the less responsive or sensitive the quantity demanded will be to a change in
price. The price elasticity of the quantity demanded is therefore lower and more inelastic.
But what about Peter's spending on petrol?
Since he does spend a significant proportion of his income on petrol, should his demand for petrol then
not be elastic?
In the case of Peter, there are two forces impacting on his elasticity – the unavailability of substitutes
and the proportion of income he spends on petrol.
The unavailability of substitutes makes it more inelastic, while the high proportion of his income that
he spends on petrol makes it more elastic. In his case, the unavailability of substitutes is the stronger
force.
 52
A consequence of this relationship between the proportion of income spent on a good or service, and
the price elasticity of the good and service, is that different income groups have different price
elasticities for the same good and service. For instance, the price elasticity of bread might be more
elastic for a poor household than for a rich household, since poor households spend a larger proportion
of their income on bread compared to rich households.
One also finds that the price elasticity of cigarettes is different for teenagers and adults.

Consider the questions below and select the answers you think are most accurate.
What do you think?

Is the price elasticity of cigarettes higher or lower for teenagers than for adults?
o Higher
o Lower

Are teenagers more price sensitive than adults?

o Yes
o No

If the government increases the tax on cigarettes, will teenagers be more discouraged than adults to
smoke?
o Yes
o No

Teenagers are more price sensitive since their incomes are more limited than those of adults and,
consequently, their price elasticity is higher.

If teenagers have a higher price elasticity than adults, they will decrease their quantity demanded
more, and therefore smoke less if the government increases the tax on cigarettes.

Time period
In the short run, Peter has little choice about the amount of petrol he uses. He might cut down on some
of his travelling – fewer trips to the shops and over weekends. In the long run, however, he has more
choices. He could, for instance, replace his car with a more fuel-efficient car, join a lift club or move to
an area closer to his work.
As a general rule, we can state the following:
 The longer the time period under consideration, the greater the price elasticity of a good or
service will be.
 This short-run versus long-run elasticity has an important impact on the way prices are set in a
market.
 Take, for example, the cost of an airline ticket from Johannesburg to Cape Town. If you
visit different airlines and you compare the cost of a ticket next week with one in three
months' time, you will probably find that purchasing an airline ticket three months in
advance is cheaper than purchasing it one week in advance.
 The reason is that you have more time to look for substitutes, and manage and change your
travel and accommodation arrangements.
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Nature of the product

We can expect that goods that are necessary for our survival will tend to be relatively inelastic. These
are things such as water, food, shelter and medical services. Luxuries, however, such as vacations,
designer clothes and shoes, or champagne, will be relatively price elastic. Whether a good is regarded
as a luxury or necessity depends on the taste and preference of the individual, and there is no exact rule
to determine what goods can be classified as luxuries or necessities.
As a general rule, we can state that if a good is regarded as a necessity, it will be relatively inelastic,

whereas if it is regarded as a luxury good, it will tend to be elastic.

Do the following activities that deal with the factors that impact on price elasticity, and then move on
to explore the link between household spending and price elasticity.

ACTIVITY 5

5.1 Which of the following factor(s) will tend to cause the demand for a good or service to be price
elastic?
a. The more substitutes there are available for the good or service
b. The more necessary the good or service is
c. The lower the proportion of income spent on the good or service
d. The longer the time period is
5.2 Indicate whether the price elasticity of demand for Toyota sport utility vehicles (SUVs) will
increase, decrease or remain the same in the following situations:
a. Other motor manufacturers enter the market, resulting in a greater variety of SUVs.
 54
b. The government bans the importation of SUVs.
c. Through advertising and marketing, Toyota is able convince the public that its SUV is the
safest.
5.3 Indicate whether the price elasticity of the demand for movie theatre tickets will increase,
decrease or remain the same because of the following:
a. Television broadcasts include more current movies.
b. The movies are released on DVD.
c. More people are able to download movies from the internet.
5.4 The following table indicates the demand for airline tickets between Johannesburg and Cape
Town for business travellers and holiday travellers.

Price (R) Business travellers Holiday travellers

(quantity demanded) (quantity demanded)
700 2 000 1 600
1 200 1 800 1400
1 700 1 600 1 200
3 000 1 400 1 000
3 500 1 200 800
4 000 1 000 600

Assume that the price increases from R3 000 to R3 500.

a. Using the midpoint method, calculate the price elasticity for business travellers and the
price elasticity for holiday makers.
b. Choose the correct option in brackets.
The price elasticity for business travellers is (more elastic, less elastic) compared to the
price elasticity for holiday travellers.
c. Which of the following might be the reason(s) for the difference between the price
elasticity for business travellers and the price elasticity for holiday travellers?
1. For business travellers travelling between Johannesburg and Cape Town, airline
tickets are more of a necessity than for holiday travellers.
2. Fewer substitutes are available for holiday travellers than for business travellers.
3. The travel costs for business travellers are paid by the business, while holiday
travellers pay for their travel costs out of their own pocket.

10.7 Household spending and price elasticity of demand

After you have worked through this section of the learning unit, you should be able to:

• explain in words and with the aid of a diagram the relationship between household spending
and price elasticity of demand
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One of the reasons we study the demand for a good or service is to help us understand the determinants
of spending by households. How much households spend on a good or service and, in particular, what
happens to their spending if the price changes, are important issues that we need to investigate further.
From the law of demand, we know that if the price of a good or service decreases, people will demand
a higher quantity of it, and if the price increases, they will demand a lower quantity of it. But what
happens to their total spending if the price changes?
 Does an increase in the price of a good or service cause households to increase or decrease
their total spending on the good or service?
 Does a decrease in the price of a good or service cause households to increase or decrease their
total spending on the good or service?

What do you think would happen to the total spending of households on petrol in the following
examples?

The price of petrol increases. The price of petrol decreases.

o Households will spend more on petrol o Households will spend more on petrol
o Households will spend less on petrol o Households will spend less on petrol
What do you think will happen to the total spending by households on restaurant meals if the
following happens?
The price of restaurant meals increases. The price of restaurant meals decreases.

o Households will spend more on restaurant o Households will spend more on restaurant
meals meals
o Households will spend less on restaurant o Households will spend less on restaurant
meals meals
Intuitively, people believe that if the price of something increases, their total spending on that good
or service will increase as well. In the next sections, we will show that this is not necessarily the
case. Whether we spend more or less depends on the price elasticity of demand.

Total spending by households on a good or service is equal to the price (P) they paid for the good or
service times the quantity (Q) they bought. In symbols, this is written as:

Total spending = 𝑃𝑃 × 𝑄𝑄
What we want to know is what happens to total spending if the price changes. Remember that as the
price changes, so does the quantity demanded – both P and Q change. It is the price elasticity that will
tell us by how much the quantity demanded changes, and thus what happens to total spending.
We have identified two main types of price elasticity, namely inelastic and elastic. Now, let's see what
happens to total spending if we have a price inelastic demand.

Total spending and price inelastic demand

A price inelastic demand has a price elasticity of less than 1 and the percentage change in quantity
demanded is less than the percentage change in price. This indicates that the quantity demand is not
that sensitive or responsive to the price.
 56

Increase in price
To see what the relationship is between a price inelastic demand and total spending, we will use the
example of Thabo's smoking habits.
You are given the following information about Thabo's smoking habits:

o Thabo smokes 10 packets of cigarettes in a week.

o The price of a packet of cigarettes is R30.
o His price elasticity is estimated at 0,5.

What do you expect will happen to his total spending on cigarettes per week if the price of a
packet of cigarettes increases by 10%?

o It will increase.
o It will decrease
o It will stay the same

To answer this question, we need to take his price elasticity coefficient for cigarettes into account.

Thabo’s weekly spending on cigarettes before the increase in price is P x Q = R30 x 10 = R300.
This information is entered in the first row of the following table:
Thabo's total spending

P Qd Total spending per

week (TS)
Weekly spending at R30 per packet R30 10 R300
Weekly spending at R33 per packet R33 9.5 R313,50

A 10% increase in the price of a packet of cigarettes increases the price to R33.
Given a price elasticity of 0,5, it means that for every 1% increase in price, the quantity demanded
decreases by 0,5%. A 10% increase in price therefore implies that the quantity demanded decreases by
10% x 0,5 = 5%.
His decrease in quantity demanded is therefore 5% x 10 packets = 0,5 packets. Thabo now smokes 10 –
0,5 = 9,5 packets of cigarettes per week, and his total weekly spending on cigarettes is R33 x 9,5 =
R313,50. This information is entered in the table above.
Looking at the information in the table, we can therefore conclude that as the price of cigarettes
increases by 10%, Thabo’s total spending on cigarettes will increase from R300 to R313,50.
What we can conclude from this is that if demand is relatively price inelastic, an increase in price will
cause an increase in total spending of the good or service. The reason for this is that the percentage
increase in price is greater than the percentage decrease in quantity demanded.
In spite of the fact that Thabo smokes fewer cigarettes, his total spending on cigarettes has increased.
 57 ECS1501/002
We can represent the above as the following chain of events:
If ep < 1 : ↑P → ↑TS
If price elasticity is smaller than 1, an increase in price will lead to an increase in total spending.

Using diagrams to illustrate total spending and price inelastic demand

We will use the same example of Thabo's smoking habits to illustrate, with the aid of diagrams, what
happens to total spending if the price of a good or service with an inelastic demand changes.
You are given the following information:
 Thabo smokes 10 packets of cigarettes a week.
 The price of a packet of cigarettes is R30.
 His price elasticity is estimated at 0,5.

Thabo's total spending

P Qd Total spending per

week (TS)
Weekly spending at R30 per packet R30 10 R300
Weekly spending at R33 per packet R33 9.5 R313,50

Next, we show graphically what happens to Thabo's total spending if the price of cigarettes increases
by 10%. The calculations we use are the same as those in our previous example, and are summarised in
the above table:

Total spending
Given the price of R30 per packet, the quantity demanded by Thabo is 10 packets a week. His total
spending on cigarettes is therefore R30 x 10 = R300. This is indicated by the area 0-R30-E-10 in the
diagram. Assuming a decrease in the supply of cigarettes, the supply curve shifts upwards and the price
increases to R33. This is an increase of 10%. This increase in the price decreases his quantity
demanded to 9,5 packets. This is a decrease of 5%. His total spending on cigarettes is now R33 x 9,5 =
R313,50. This is indicated by the area 0-R33-E1-9,5. Comparing his total spending at R30 (area 0-R30-
E-10) with his total spending at R33 (area 0-R33-E1-9,5), it is clear that his total spending increases as
the price of cigarettes increases.
 58
From this, we can conclude that if demand is inelastic, like in the case of cigarettes, an increase in the
price leads to an increase in total spending.
In the above explanation, we compared Thabo's total spending before and after the increase in price,
and then reached the conclusion that if demand is inelastic, an increase in price increases total
spending.

Decrease in price
What happens to Thabo's total spending if the price of cigarettes decreases by 10%?
Do the following activity by following the same steps as above to see whether a decrease in the price of
cigarettes increases or decreases his total spending.

ACTIVITY 6

Thabo smokes 10 packets of cigarettes a week and his price elasticity is estimated at 0,5. The price of a
packet of cigarettes is R30.

6.1 Complete the following table to determine whether his total spending increases or decreases if the
price of cigarettes decreases by 10%.

P Qd Total spending per

week

Weekly spending at R30

Weekly spending at R27

6.2 Choose the correct options in brackets.

Thabo's demand for cigarettes is (elastic, inelastic), and a decrease in the price of cigarettes
(decreases, increases) his total spending.
6.3 Is the following statement true or false?
What we can conclude from this activity is that in the case of a price inelastic demand, a
decrease in price will cause a decrease in total spending on the good or service. This happens
because the percentage decrease in price is greater than the percentage increase in the quantity
demanded.
6.4 Indicate which diagram represents his total weekly spending before the 10% decrease in price and
which diagram represents Thabo’s total weekly spending after the 10% decrease in price.
 59 ECS1501/002

Diagram A Diagram B

6.5 Is the following statement true or false?

If the price of cigarettes decreases by 10%, Thabo smokes more, but his total spending on
cigarettes decreases.

Summary

Returning to our original questions:

 Does an increase in the price cause households to increase or decrease their total spending on
the good or service?
 Does a decrease in the price cause households to increase or decrease their total spending on
the good or service?

What we can say now is that if the price elasticity of a good or service is inelastic (less than 1), an
increase in price will increase total spending, while a decrease in price will decrease total spending.
If ep < 1: ↑P → ↑TS
If ep < 1: ↓P → ↓TS

Total spending and price elastic demand

We know now that if the demand for a product is price inelastic, an increase in the price will increase
total spending, while a decrease in price will decrease total spending.
Does this also apply to a price elastic demand?
If demand is price elastic, it has a price elasticity of more than 1. For price elastic demand, the
percentage change in price is smaller than the percentage change in quantity demanded, which indicates
that the quantity demanded is relatively sensitive or responsive to the price.
We will use the demand for restaurant meals, which has a price elasticity of 2,5, as an example to see
what happens to total spending if the price changes.
 60
The price elasticity of restaurant meals is 2,5, and at a price of R100 a meal, households buy 1 000
meals per month.
What do you expect will happen to total spending on restaurant meals if the price of restaurant
meals increases by 10%?

o It will increase.
o It will decrease
o It will stay the same

Let's use our example top see what might happen.

At R100 a restaurant meal, the total spending by households is P x Q = R100 x 1 000 = R100 000. This
information is entered in the following table in the second row.
Total spending on restaurant meals

P Qd Total spending per

month (TS)
Monthly spending at R100 per meal R100 1,000 R100,000
Monthly spending at R110 per meal R110 750 R82,500

A 10% increase in the price of a restaurant meal increases the price to R110. Given a price elasticity of
2,5, it means that a 10% rise in the price will decrease the quantity demanded by 25% (10% x 2,5 =
25%). The quantity demanded therefore decreases by 25% x 1 000 = 250. At R110, the quantity
demanded is therefore 1000 – 250 = 750 restaurant meals.
 The total spending at R110 per meal is 750 x R110 = R82 500.
 Because the price of restaurant meals increased by 10%, their total spending declined from
R100 000 to R82 500.
 This information is entered in the second row of the table above.

What we can conclude from this is that in the case of a price elastic demand, an increase in price will
cause a decrease in total spending of the good or service. The reason for this is that the percentage
increase in price is smaller than the percentage decrease in quantity demanded.
The above can be represented as a chain of events as follows:
If ep > 1: ↑P → ↓TS
If price elasticity is greater than 1, then an increase in the price will result in a decrease in total
spending.

Using diagrams to illustrate total spending and price elastic demand

We will use the same example of the demand for restaurant meals to illustrate what happens with total
spending if the price of a good or service with an elastic demand changes. Remember, in this section
we are studying the effect of an increase in price.
The price elasticity of restaurant meals is 2,5, and at a price of R100 a meal, households buy 1 000
meals per month.
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What will happen to the total spending by households on restaurant meals if the price of a restaurant
meal increases by 10%?
The calculations we use are the same as those in our previous example and they are summarised in the
following table:
Total spending on restaurant meals

P Qd Total spending per

month (TS)
Monthly spending at R100 per meal R100 1,000 R100,000
Monthly spending at R110 per meal R110 750 R82,500

In the section below, we show graphically what happens to total spending if the price of restaurant
meals increases by 10%.

Total spending and elastic demand

Given a price of R100 per restaurant meal, the quantity demanded in a month is 1 000 meals. The total
spending on restaurant meals at R100 is R100 x 1 000 = R100 000. This is indicated by the area 0-
R100-E-1 000 in the diagram.
A decrease in the supply of restaurant meals shifts the supply curve upwards, and the price increases to
R110 (which is a 10% increase). This increase in the price of restaurant meals decreases the quantity
demanded to 750 meals (which is a 25% decrease). The total spending on restaurant meals is now R110
x 750 = R82 500. This is indicated by the area 0-R110-E1 - 750.
Comparing total spending at R100 (area 0-R100-E- 1 000) with total spending at R110 (area 0-R110-
E1 - 750), it is clear that total spending decreases as the price of restaurant meals increases. From this,
we can conclude that if demand is elastic, like in the case of restaurant meals, an increase in the price
leads to a decrease in total spending.

Decrease in price
We have established that if demand is elastic, such as the demand for restaurant meals, an increase in
the price will decrease total spending.
What happens if the price decreases?
Do the following activity to see what happens to total spending on restaurant meals if the price of
restaurant meals decreases.
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ACTIVITY 7

The price elasticity of restaurant meals is 2,5, and at a price of R100 a meal, households buy 1 000
meals per month.

7.1 Complete the following table to determine whether households will increase or decrease their
total spending on restaurant meals if the price of restaurant meals decreases by 10%:

P Qd Total spending per month

(TS)
Monthly spending at R100 per meal
Monthly spending at R90 per meal

7.2 Choose the correct option in brackets

The demand for restaurant meals is (elastic, inelastic) and a decrease in the price of restaurant
meals (decreases, increases) households' total spending on restaurant meals.
7.3 Is the following statement true or false:
What we can conclude from this activity is that in the case of a price elastic demand, a decrease
in price will cause an increase in total spending on the good or service. The reason for this is
that the percentage decrease in price is smaller than the percentage increase in quantity
demanded.
7.4 Indicate which diagram represents the total weekly spending on restaurant meals before the 10%
decrease in price and which diagram represents total weekly spending after the 10% decrease in
price of restaurant meals.
Diagram A Diagram B

Summary
Returning to our original questions:
 Does an increase in the price cause households to increase or decrease their total spending on
the good or service if demand is elastic?
 Does a decrease in the price cause households to increase or decrease their total spending on
the good or service if demand is elastic?
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What we can say now is that if the price elasticity of a good or service is elastic (greater than 1), an
increase in price will decrease total spending, while a decrease in price will increase total spending.

Comparing inelastic and elastic demand

Returning to our original question, we can now answer it:
 Does an increase in the price cause households to increase or decrease their total spending on
the good or service?
 Does a decrease in the price cause households to increase or decrease their total spending on the
good or service?
The answer is that it depends on the price elasticity.

ACTIVITY 8

Choose the correct terms in brackets in the following table, which provides a summary of the impact of
a price change on total spending:

If the price If the price

increases decreases
Inelastic demand The % change in Total spending Total spending
price is (greater, (increases, (increases,
smaller) than the % decreases, stays the decreases, stays the
change in quantity same). same).
demanded.
Elastic demand The % change in Total spending Total spending
price is (greater, (increases, (increases,
smaller) than the % decreases, stays the decreases, stays the
change in quantity same). same).
demanded.

Now that we have established that if:

 demand is price inelastic;
 an increase in price will increase total spending by households, and
 a decrease in price will decrease total spending by households.
And if:
 demand is price elastic;
 an increase in price will decrease total spending by households, and
 a decrease in price will increase total spending by households.
We can now turn our attention to what happens to the total revenue of firms if the price of a good or
service changes.
 64

10.8 Firms' total revenue and price elasticity

After you have worked through this section of the learning unit, you should be able to:

• explain with the aid of words and diagrams the relationship between a firms’ total revenue and
price elasticity

In this section, we take a closer look at what happens to the total revenue of firms if prices change.
While households are concerned about what happens to their total spending if prices change, firms are
concerned about what happens to their total revenue if prices change. Firms would typically want to
understand what will happen to their total revenue if the price of the good or service they supply
changes.
 Will a price increase cause their total revenue to increase or decrease?
 Will a price decrease cause their total revenue to increase or decrease?

To answer these questions, you need to understand the relationship between price elasticity and total
revenue.
What do you think will happen to the total revenue of cigarette suppliers if the price of cigarettes
increases?

o It will increase.
o It will decrease
o It will stay the same

What do you think will happen to the total revenue of cigarette suppliers if the price of cigarettes
decreases?

o It will increase.
o It will decrease
o It will stay the same

What do you think will happen to the total revenue of a restaurant if the price of a restaurant meal
increases?

o It will increase.
o It will decrease
o It will stay the same

What do you think will happen to the total revenue of a restaurant if the price of a restaurant meal
decreases?

o It will increase.
o It will decrease
o It will stay the same

You already know the answers: All you need to do is to make the link between total spending by
households and total revenue of firms.
 65 ECS1501/002

Link between total spending and total revenue

The total revenue of firms and the total spending by households are directly related. As total spending
by households changes, the total revenue of firms will change. When households spend more, firms sell
more, and their total revenue thus increases.
However, if households decrease their total spending, firms will sell less and their total revenue will
decline.
As explained earlier, total spending by households is equal to the price they pay for a good or service
times the quantity bought of the good or service:
𝑇𝑇𝑇𝑇 = 𝑃𝑃 × 𝑄𝑄

The total revenue of firms is also equal to the price paid for the good or service times the quantity sold
to households:
𝑇𝑇𝑇𝑇 = 𝑃𝑃 × 𝑄𝑄

In other words:
𝑇𝑇𝑇𝑇 = 𝑃𝑃 × 𝑄𝑄 = 𝑇𝑇𝑇𝑇

Total spending and total revenue are two sides of the same coin.
 For example, if the total spending of households on restaurant meals is R100 000, then the
total revenue firms receive by supplying the restaurant meals is also R100 000.

If households increase their spending on restaurant meals by say, R10 000, then the total revenue of
firms supplying restaurant meals also increases by R10 000.

Total revenue and inelastic demand

In the section on household spending and price elasticity, we argued that if demand is price inelastic, an
increase in price will increase total spending by households, while a decrease in price will decrease
total spending by households. What does this imply for the total revenue of firms?
Do the following activity to see what happens to the total revenue of a firm if demand is inelastic and
the price increases.
Remember that the total revenue of firms is directly related to households total spending. If you are
unsure about what happens to total spending if demand is inelastic, quickly revise it.
 66

ACTIVITY 9

Assume you are the financial manager of a firm that produces and sells cigarettes and your managing
director asks you what would happen to total sales and total revenue if the price of a packet of
cigarettes were to increase by 10%.
Based on the following information, what would your answer be?
The price elasticity of cigarettes is 0,5. At a price of R30, your company currently sells 10 000 packet
of cigarettes a week.
9.1 Complete the following table to indicate what would happen to your total sales and revenue if the
price of cigarettes were to increase by 10%:

P Qd (Sales) Total revenue per week

Weekly total revenue at R30

Weekly total revenue at R33

9.2 Complete the following by choosing the correct words in brackets and fill in the gaps:
a. A 10% increase in the price of a packet of cigarettes would (decrease, increase) total sales
by 500 packets of cigarettes and (increase, decrease) total revenue by R13 500.
b. You would tell the managing director that while an increase in price (decreases, increases)
the quantity demanded, the total revenue (increases, decreases) total revenue.
9.3 Which one of the following diagrams illustrate the impact of a 10% rise in the price of a packet
cigarettes on total revenue?
Diagram A Diagram B
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In our activity, we established that if demand is inelastic, then an increase in price will lead to an
increase in total revenue. This is represented in the following diagram:

Inelastic demand and total revenue

An increase in the price of a packet of cigarettes from R30 to R33 decreases the quantity demanded
from 10 000 to 9 500. This has the impact that total revenue increases from R300 000 to R313 500.
So what happens to total revenue if the price decreases?
Do the following activity to see what happens to total revenue.

ACTIVITY 10

Your managing director tells you that she has heard of the law of demand, and that according to this
law, a decrease in price will increase the quantity demanded. She therefore proposes that the company
should decrease the price of cigarettes so that it can sell more, and by selling more, total revenue will
increase.
The price elasticity of cigarettes is 0,5. At a price of R30, you company currently sells 10 000 packet of
cigarettes per week. Your managing director proposes that the price of a packet of cigarettes should be
decreased by 10%.
What would your advice be based on the above information?
10.1 Complete the following table to indicate what would happen to your total sales and revenue if the
price of cigarettes were to decrease by 10%:

P Qd Total revenue per week

Weekly total revenue at R30

Weekly total revenue at R27

10.2 Complete the following by choosing the correct word in brackets and fill in the gaps:
a. You (agree, do not agree) with her.
b. A 10% decrease in the price of a packet of cigarettes would (decrease, increase) total sales
by 500 packets of cigarettes and (increase, decrease) total revenue by ______.
c. While a decrease in price does cause (an increase, a decrease) in quantity demanded, as
stated by the law of demand, it does not translate into (an increase, a decrease) in total
revenue because demand is (inelastic, elastic).
 68
10.3 Which one of the following diagrams illustrate the impact of a 10% decrease in the price of a
packet cigarettes on total revenue?
Diagram A Diagram B

In conclusion, we can therefore state the following with regards to a price inelastic demand:
1. Since goods and services, such as salt and petrol and medical services, are price inelastic,
the quantity demanded by households is not that responsive to a change in price.
2. If the price of the good or service changes, the change in quantity demanded by households
is relatively small compared to the change in price.
3. The consequence of this for total spending by households is that in the event of a rise in the
price of the good or service, the total spending by households on the good or service
increases.
Since the total spending by households is the total revenue of firms, the total revenue of firms increases
as well.
However, if the price of a price inelastic good or service falls, total spending by households declines,
and the total revenue of firms therefore declines as well.

Total revenue and elastic demand

In the section on household spending and price elasticity, we argued that if demand is price elastic, an
increase in price will reduce total spending by households, while a decrease in price will increase total
spending by households.
Do the following activity to see what happens to the total revenue of a firm if demand is elastic and the
price increases. Remember that the total revenue of firms is directly related to the total spending by
households.

ACTIVITY 11

Assume you are a restaurant owner and the price elasticity of restaurant meals is 2,5.
What would happen to your total revenue if the price of a restaurant meal increases?
a. It increases.
b. It decreases.
c. It stays the same.
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From our activity, we have established that if demand is elastic, then an increase in price will lead to a
decrease in total revenue. This is represented in the following diagram:

Elastic demand and total revenue

An increase in price from R100 to R110 per restaurant meal decreases the quantity demanded from 1
000 to 750. This has the impact that total revenue decreases from R100 000 to R82 500.
What will happen to total revenue if demand is elastic and the price decreases?
Using the example of restaurant meals with an elasticity of 2,5, we can graphically show what will
happen to total revenue is the price decreases by 10%.
Monthly revenue

P Qd Total revenue per

month

Monthly revenue at R100 per meal R100 1 000 R100 000

Monthly revenue at R90 per meal R90 1 250 R112 500

Elastic demand and total revenue

A decrease in price from R100 to R90 increases the quantity demanded from 1 000 to 1 250. This has
the impact that total revenue increases from R100 000 to R112 500. The total gain in revenue is R112
500 – R100 000 = R12 500.
 70

Summary
In conclusion, we can therefore state the following:
 Since a good or service, such as a pair of shoes or a movie is price elastic, the quantity
demanded by households is highly responsive to a change in price.
 If the price of the good or service changes, the change in quantity demanded by households is
relatively large compared to the change in price. The consequence of this for total spending by
households, and the total revenue of firms, is that in the event of a rise in the price of the good
or service, the total spending by households on the good or service decreases.
 Since the total spending by households is the total revenue of firms, the total revenue of firms
declines as well.
 However, if the price of a price elastic good or service falls, total spending by households
increases, and the total revenue of firms therefore increases as well.
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ANSWERS TO THE
ACTIVITIES

Activity 1
1.1
a. The statement is false.
It provides a measure of how sensitive or responsive the quantity demanded is to a change in
the price of a good or service. Note that the causality is from a change in the price to a change in
quantity demanded.

∆𝑃𝑃 → ∆𝑄𝑄𝑑𝑑
b. The statement is true.
You will indeed know what will happen to the quantity demanded of petrol if the price of petrol
changes.
c. The statement is false.
If you know the value of the price elasticity of petrol, you will be able to say by how much the
quantity demanded will change in relation to a given change in the price. You already know from
the law of demand that an increase in price reduces the quantity demanded.
d. The statement is false.
To predict what would happen to the price of petrol, you would need to know the demand and
supply functions of petrol. What you would be able to predict is by how much the quantity of
petrol would change if the price of petrol were to change.
e. The statement is true.
The greater the price elasticity, the bigger the impact will be of a change in the price on the
quantity demanded. If, for instance, the price of ice cream and petrol increases, households will
respond by reducing their quantity demanded of ice cream and petrol, but their decrease in the
quantity demanded of ice cream will be relatively larger.
f. The statement is false.
The phrase "sensitivity or responsiveness to" relates to how people adjust their quantity
demanded if the price changes and not how upset they are if the price changes. The reason why
people are upset if the price of petrol changes is because they find it difficult to reduce their
quantity of petrol demanded. In other words, it is because their quantity demanded is insensitive
or unresponsive that they are upset.
 72

g. The statement is true.

Since price elasticity tells us what happens to the quantity demanded by households, the business
will be able to predict what will happen to the quantity sold (its sales).
h. The statement is true.
If you know the price elasticity of fresh tomatoes, you know what will happen to your sales (the
quantity demanded), and since your revenue depends on your sales, you will know what will
happen to your revenue. In other words, if you know that a decrease in price will increase the
quantity demanded by 100, and the price is R10 per packet, your sales as well as your revenue
will increase by R1 000.

∆𝑃𝑃 → ∆𝑄𝑄𝑑𝑑 → ∆Sales → ∆𝑇𝑇𝑇𝑇

1.2 Diagram B.
In diagram B we have an increase in price due to a decrease in supply. As the price increases an
upward movement along the demand curve takes place which leads to a decrease in the quantity
demanded. It is this impact of a change in price on quantity demanded that we will measure.
Diagram A represents the impact of a change in demand on the price and the quantity. This is not
what we will measure.

Activity 2
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The data in the diagram is reproduced in the following table:
P Qd
R100 1 000
R110 750

In the above diagram, we see that as the price increases from R100 to R110, the quantity
demanded decreases from 1 000 to 750. We now have sufficient data to calculate the price
elasticity coefficient for restaurant meals for the price range R100 to R110. We do this by
applying the formula for price elasticity.
(𝑄𝑄2 − 𝑄𝑄1 )
𝑄𝑄1 + 𝑄𝑄2
𝑒𝑒𝑝𝑝 = 2
(𝑃𝑃2 − 𝑃𝑃1 )
𝑃𝑃1 + 𝑃𝑃2
2
(1 000 − 750)
(750 + 1 000)
=
(110 − 100)
(100 + 110)
250
= 750
1
10
210
= 3

What this means is that for every 1% increase in the price, the quantity demanded will decrease by 3%,
and for every 1% decrease in price, the quantity demanded will increase by 3%.

Activity 3

3.1
a. Using the formula for price elasticity ep= (% ∆Qd)/(% ∆P), the % change in price is greater
that the percentage change in quantity demanded for electricity (0,13) and fuel (0,6) giving
it a value smaller than 1. For private education (1,1) and restaurant meals (2,27), the %
change in price is smaller than the % change in quantity demanded giving it a value greater
than 1.
b. If you compare the price elasticity of electricity of 0,13 with the price elasticity of
restaurant meals of 2,27, we can say that consumers are more sensitive to a change in the
price of restaurant meals than to a change in the price of electricity.
3.2
a. If the % change P is greater than the % change in Qd, the demand is relatively inelastic and
the price elasticity coefficient is smaller than 1.

Activity 4

4.1
a. If the % change in P is greater than the % change in Qd, then the demand is relatively
inelastic.
 74
4.2
b. A relatively elastic demand implies that the % change in price is smaller than the % change
in Qd.
4.3
b. A relative elastic demand implies that the percentage change in price is smaller than the
percentage change in quantity demanded and the price elasticity coefficient is greater than
1.
4.4
a. Since the % change in P (12%) is greater than the % change in quantity demand (6%), the
demand is relatively inelastic.
4.5
b. Since the % change in P (8%) is smaller than the % change in quantity demand (12%), the
demand is relatively elastic.

4.6

o Relatively inelastic
Categories o 0 < ep < 1
o It has a relatively low price elasticity value.

In this case, the product is relatively inelastic since the % change in Qd is less than the % change
in P. The value of ep is therefore less than 1 and the product has a relatively low price elasticity
value, and it can be argued that people are not very price sensitive for this product.

4.7

o Relatively elastic
o 1 < ep < ∞
o It has a relatively large price elasticity value.
Categories
o The % change in Qd is greater than the % change in P.
o It can be argued that for this product people are price
sensitive.

In this case, ep >1 and it is therefore relatively price elastic meaning that the % change in Qd is
greater than the % change in P. It has a relatively large price elastic value and it can be argued
that for this product people are price sensitive.
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4.8

o Relatively inelastic
o 0 < ep < 1
o It has a relatively low price elasticity value.
Categories
o The % change in Qd is less than the % change in P.
o It can be argued that for this product people are not very
price sensitive.

Using the midpoint method, the price elasticity for maize is 0.59. This indicates that maize has a
price elasticity that is less than 1 since the % change in P is greater than the % change in Qd. It
therefore has a relatively low price elasticity value and it can be argued that in the case of maize
people are not price sensitive.

4.9
a. Relatively inelastic
b. Relatively elastic
c. Unitary elastic

Activity 5

5.1 a and d.
The more substitutes there are and the longer the time period, the more elastic the demand for the
good or service will be.
The more necessary and the lower the proportion of income spend on the good, the more inelastic
it will be.
5.2
a. Increase
b. Decrease
c. Decrease
 76
With more manufactures, there are more substitutes, and the impact of this is that the price
elasticity of demand for Toyota SUVs becomes more elastic. In other words, the elasticity
coefficient increases.
If the government bans the importation of SUVs, then fewer substitutes are available and the
impact of this will be that the price elasticity of demand for Toyota SUVs becomes more
inelastic. In other words, the elasticity coefficient decreases.
If the public believe that Toyota SUVs are safer, there are fewer substitutes available in their
minds, and this will result in the price elasticity of demand for Toyota SUVs becoming more
inelastic. In other words, the elasticity coefficient decreases.
5.3 a, b and c.
All of these factors increase the number of substitutes available. The impact of this will be that
the price elasticity of movie theatre tickets becomes more elastic. In other words, the elasticity
coefficient increases.
5.4 a. Using the midpoint method, the price elasticity for business travellers is 1, and the price
elasticity for holiday makers 1,44.
b. The price elasticity for business travellers is less elastic compared to the price elasticity for
holiday travellers.
c. 1 and 2.
In the example, the price elasticity for business travellers is 1, while that for holiday makers is
1,44. This indicates that the demand for airline tickets by business travellers is unitary (it has a
value equal to 1), while the demand for airline tickets by holiday travellers is elastic (it has a
value of more than 1). It therefore follows that the price elasticity for business travellers is less
elastic compared to the price elasticity for holiday travellers.
The following are possible reasons for business travellers facing a less elastic demand for airline
tickets:
Business travel is more of a necessity than a luxury good. Business travellers usually have to be
at a meeting at a specific time and place.
Airline travel is the quickest way to travel between Johannesburg and Cape Town, and given the
fact that time is valuable for business travellers they tend not to regard the other modes of travel
between Johannesburg and Cape Town as viable options. There are therefore fewer substitutes
available for business travellers than for holiday makers.
For business travellers, the cost of airlines tickets is paid by the business and this will indeed tend
to decrease the elasticity of the demand for airline tickets.

Activity 6

6.1 Thabo's weekly spending before the increase in price is P x Q = R30 x 10 = R300. This
information is entered in the second row of the following table

P Qd Total spending per

week

Weekly spending at R30 R30 10 R300

Weekly spending at R27 R27 10,5 R283,50

 77 ECS1501/002
A 10% decrease in the price of a packet of cigarettes reduces the price to R27.
A price elasticity of 0,5 means that a 10% decrease in the price will increase the quantity
demanded by 5%. (For every 1% decrease in price, the quantity demanded increases by 0,5%. A
10% decrease in price therefore implies that the quantity demanded increases by 10% x 0,5% =
5%.)
Thabo’s increase in quantity demanded is therefore 5% x 10 packets = 0,5 packets. He now
smokes 10 + 0,5 = 10,5 packets of cigarettes per week, and his total weekly spending on
cigarettes is R27 x 9,5 = R283,50. This information is entered in row 3 in the above table.
Looking at the information in the table, we can therefore conclude that if the price of cigarettes
decreases by 10%, Thabo’s total spending on cigarettes will decrease from R300 to R283,50. He
now spends R16,50 less on cigarettes.
While Thabo does in fact smoke more, his total expenditure on cigarettes declines from R300 to
R283,50.

6.2 Thabo's demand for cigarettes is inelastic, and a decrease in the price of cigarettes decreases his
total spending.

6.3 The statement is true.

6.4 Diagram A indicates his spending before the decrease in price, while diagram B indicates his
spending after the decrease in price.

6.5 The statement is true. Thabo now smokes 0,5 packets of cigarettes more (an increase of 5%). In
spite of the fact that he smokes more cigarettes, his total spending has declined because the %
decrease in price is greater than the % increase in quantity.
Activity 7

7.1 At R100 per restaurant meal, the total spending by households is P x Q = R100 x 1 000 = R100
000. This information is entered in the second row in the following table:

P Qd Total spending per

month (TS)
Monthly spending at R100 per meal R100 1 000 R100 000
Monthly spending at R90 per meal R90 1 250 R112 500

7.2 The demand for restaurant meals is elastic, and a decrease in the price of restaurant meals
increases households' total spending on restaurant meals.

7.3 The statement is true.

What we can conclude from this activity is that in the case of a price elastic demand, a decrease
in price will cause an increase in total spending on the good or service. The reason for this is
that the percentage decrease in price is smaller than the percentage increase in quantity
demanded.
7.4 Diagram A represents the total spending before the decrease in price, while diagram B represents
the total spending after the decrease in price.
 78

Activity 8

If the price increases If the price

decreases
Inelastic demand The % change in Total spending Total spending
price is greater, than increases. decreases.
the % change in
quantity demanded.
Elastic demand The % change in Total spending Total spending
price is smaller than decreases. increases.
the % change in
quantity demanded.

Activity 9

9.1

P Qd (Sales) Total revenue per week

Weekly total revenue at R30 R30 10 000 R300 000

Weekly total revenue at R33 R33 9 500 R313 500

A 10% increase in the price of a packet of cigarettes increases the price to R33.
A price elasticity of 0,5 would mean a 10% rise in the price would reduce the quantity demanded
by 5%. (For every 1% increase in price, the quantity demanded decreases by 0,5%. A 10%
increase in price therefore implies that the quantity demanded decreases by 10% x 0,5% = 5%.)
The decrease in sales due to the decrease in quantity demanded is therefore 5% x 10 000 packets
= 500 packets. Customers are now smoking 10 000 – 500 = 9 500 packets of cigarettes per week
and your total revenue is R33 x 9500 = R313 500. This information is entered in row 3 in the
above table.
Looking at the information in the table, we can therefore conclude that as the price of cigarettes
increases by 10%, your total revenue from cigarettes will increase from R300 000 to R313 500.
The total revenue therefore increases by R313 500 – R300 000 = R13 500.

9.2 You can now inform your managing director about the following:
A 10% increase in the price of a packet of cigarettes would decrease total sales by 500 packets of
cigarettes and increase total revenue by R13 500.
You would tell the managing director that while an increase in price decreases the quantity
demanded, the total revenue increases.

9.3 Diagram A.

Activity 10

10.1 The weekly total revenue before the decrease in price is P x Q = R30 x 10 000 = R300 000. This
information is entered in the second row of the following table:
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P Qd (Sales) Total revenue per week

Weekly total revenue at R30 R30 10 000 R300 000

Weekly total revenue at R27 R27 10 500 R283 500

A 10% decrease in the price of a packet of cigarettes reduces the price to R27.
Given a price elasticity of 0,5, it means that a 10% decrease in the price would increase the
quantity demanded by 5%. (For every 1% decrease in price, the quantity demanded increases by
0,5%. A 10% decrease in price therefore implies that the quantity demanded increases by 10% x
0,5% = 5%.)
The increase in sales due to the increase in quantity demanded is therefore 5% x 10 000 packets =
500 packets. Your customers are now smoking 10 000 + 500 = 10 500 packets of cigarettes per
week and your total revenue is R27 x 10 500 = R283 500. This information is entered in row 3 in
the above table.
Looking at the information in the table, we can therefore conclude that as the price of cigarettes
decreases by 10%, your total revenue from cigarettes will decrease from R300 000 to R283 500.
The total revenue therefore decreases by R300 000 – R283 500 = R16 500.
10.2 You can now inform your managing director that you do not agree with her.
A 10% decrease in the price of a packet of cigarettes will increase total sales by 500 packets of
cigarettes and decrease total revenue by R16 500.
While a decrease in price does cause an increase in quantity demanded, as stated by the law of
demand, it does not translate into an increase in total revenue because demand is inelastic.
10.3 Diagram A.

Activity 11
Total revenue decreases.
Given a price elasticity of 2,5, it means that a 1% rise in the price will decrease the quantity demanded
by 2,5%. And since the % decrease in the quantity demanded is greater than the % increase in price
total revenue will decrease.
 80

CHECKLIST

Well Satis- Must

factory redo
Concepts and explanations
I am able to
define the price elasticity of demand
explain how price elasticity of demand is measured
explain the meaning of a specific elasticity coefficient (say ep = 1,5) –
in other words, to apply the general formula
distinguish between the five different categories of price elasticity of
demand
explain the most important determinants of price elasticity of demand
explain the relationship between households spending and price
elasticity of demand
explain the relationship between total revenue of a firm and price
elasticity of demand
Diagrams
I am able to
(i) show on a diagram
(ii) explain with or without the aid of a diagram
the concept price elasticity of demand
the different types of price elasticity of demand
the value of price elasticity of demand at different points on a linear
demand curve
the relationship between household spending and price elasticity of
demand
the relationship between the total revenue of a firm and price
leasticity of demand
Calculations
I am able to
calculate price elasticity of demand using the formula for arc
elasticity (midpoint method)