How demand elasticity and price changes affect total expenditures

By looking at demand elasticity, we can determine changes in total consumer spending on a product when its price changes. We can do this in three different ways: by looking at (1) changes in an individual’s total spending, using the demand elasticity from his or her demand curve for the product, (2) changes in the total combined spending of all consumers, using the elasticity from the total market demand curve, or (3) changes in total consumer spending on the product, using the demand curve facing that firm that produces it. In other words, this third method allows us to look at elasticity based not on what consumers spend, but on what the producer receives from selling the product.
Total expenditures (or revenues) simply amount to the price of the product times the number of units of it purchased (or sold).
Because total expenditures are equal to the price times the quantity, and because the price and the quantity move in opposite directions, the net effect of a price change on the total spending on a product depends upon whether the (percentage) price change or the (percentage) quantity change is greater.
When demand is inelastic, the price elasticity coefficient is less than 1. This means that the percentage change in price is greater than the percentage change in quantity. Therefore, when demand is inelastic, the change in the price will dominate and, as a result, the price and total expenditures will change in the same direction. In other words, when the price of an inelastic product (say, cigarettes) increases, spending on it will increase, too – and vice cress. On the other hand, when demand is elastic, the change in quantity will be greater than the change in the price. As a result, the impact of the change in quantity will dominate, and therefore the price and expenditures will move in opposite directions. In other words, when the price of an elastic product (say, a ballpoint pen) – increases, spending on it will decrease and vice versa. When demand elasticity is unitary, the change in quantity demanded will be equal in magnitude to the change in price. With regard to their impact on total expenditures, these two effects will exactly offset each other. Thus, when price elasticity of demand is equal to 1,total expenditures will remain unchanged as price changes.
The demand curves can also be used to show the link between elasticity and changes in total spending. In the case of cigarettes (part b), the price elasticity of demand for the price increase from $1.00 to $1.50 is 0.26, indicating that demand is inelastic. This increase in cigarette prices leads to an increase in spending on the product from $100 million ($1.00 X 100 million units) to $135 million ($1.50 X 90 million units). If the change had occurred in the opposite direction, with the price falling from $1.50 to $1.00, total expenditures would have declined.
The price elasticity of demand for a ballpoint pen when its price increases from $1.00 to $1.50  is 3.0, indicating that demand is elastic. This increase in the price of ballpoint pens lowers total consumer spending on the product from $100,000 ($1.00 X 100,000 pens) to $37,500 ($1.50 X 25,000 pens). If the change had occurred in the opposite direction, with the price falling from $1S O to $1.00, total expenditures would have risen.
You can see how important it is for business decision makers to understand the concept of elasticity.When a fm increases the price of its product, its revenues may rise, fall, or remain the same. If the demand for the firm’s product is inelastic, the higher price will expand the firm’s total revenue. However, if the demand for the firm’s product is elastic, a price increase will lead to substantially lower sales and a decline in total revenue. In the case of unitary elasticity, the price increase will leave total revenue unchanged.
Beyond the price elasticity of demand, two other elasticity relationships are important in any given market.

Tags: Expenditures, financial market, insurance, payday loans, price changes