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.

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:

  • Thabo smokes 10 packets of cigarettes in a week.
  • The price of a packet of cigarettes is R30.
  • 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%?

  • It will increase.
  • It will decrease
  • 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.