commodity Price Elasticity of demand
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Potatoes 0.3
If I know there is a fall in the price of potatoes how do i predict the corresponding direction of change in total spending?
Total spending on potatoes is P*Q. Elasticity is (%change in Q)/(%change in P). So, if prices fall by 10%, quantity will rise by 3%. Now total spending is (.9*P)*(1.03*Q). Take it from here and draw your conclusions.
I don't know what the decrease of the price of potatoes is, so how do i figure out if the total spending will go up or down??
Given you know the price elasticity, you can tell in at least two ways; mathmatically and logically. In my previous example I showed a 10% tax decrease. But the decrease could be anything (reasonable), and you would still get the same total spending direction. If price falls by (1-x) then quantity rises by (1+.3x) where x is the percentage change in price. The combination is (1-x)*(1+.3x) = 1-.7x-.3x^2. which must be less than 1 for any positive x.
Logically now. If price falls by some x percent and quantity rises by something less than x, what has got to happen to Price time quantity. Gotta go down.
Generally speaking, the effect on spending is a wash when the elasticity is 1.0. With and elastic demand, >1, then a decrease in price leads to an increase in spending.
To determine the corresponding direction of change in total spending when there is a fall in the price of potatoes, you can follow these steps:
1. Calculate the percentage change in price. For example, if the price of potatoes falls by 10%, the percentage change in price would be -10%.
2. Use the price elasticity of demand formula to calculate the percentage change in quantity. In this case, the price elasticity of demand for potatoes is 0.3. So, the percentage change in quantity would be 0.3 multiplied by the percentage change in price. For a 10% price decrease, the percentage change in quantity would be 0.3 multiplied by -10%, which is -3%.
3. Now that you have the percentage change in price and quantity, you can predict the corresponding direction of change in total spending. Total spending is calculated by multiplying price and quantity (P * Q). In this case, the total spending formula would be (0.9 * P) * (1.03 * Q), where 0.9 represents a 10% price decrease and 1.03 represents a 3% increase in quantity.
4. Analyze the result. If the calculated value of total spending is greater than the initial total spending for potatoes, then the total spending would go up. Conversely, if the calculated value is less than the initial total spending, then the total spending would go down.
However, if you don't know the exact percentage decrease in the price of potatoes, you can still determine the direction of change in total spending by considering the price elasticity of demand. Generally, if the price elasticity is greater than 1 (elastic demand), a decrease in price will lead to an increase in spending. On the other hand, if the price elasticity is less than 1 (inelastic demand), a decrease in price will result in a decrease in spending.