Introduction

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:

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 blue 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 orange area 0-R33-E1-9,5. Comparing his total spending at R30 (blue area 0-R30-E-10) with his total spending at R33 (orange area 0-R33-E1-9,5), it is clear that his total spending increases as the price of cigarettes increases.

Total Spending

Total Spending

Total Spending

Total Spending

Total Spending

Total Spending

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.