Introduction

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

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
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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

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.

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.

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

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.

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The statement is true.

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.

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

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.

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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.

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.