Introduction

How we react depends to a large degree on what kind of good or service it is and by how much the price increases.

In the past, an increase in the price of bread in Iran has caused massive protests, an increase in public transport fares in Brazil led to violent protests, and in South Africa a rise in the price of petrol usually leads to strong verbal protests from motorists and taxi commuters.

Which one of the following would upset you the most?



Most people will be more upset if the price of petrol rises than if the price of ice cream rises.

Think for a moment why people are more upset if the price of petrol rises than if the price of ice cream rises. Is it because...




It is easier to eat less ice cream than to use less petrol. As the price of petrol increases, it is very difficult to decrease the quantity of petrol we demand. That is probably why we get more upset if the price of petrol rises than if the price of ice cream rises.

To get a better understanding of how households and firms react, and how they are influenced by price changes, we need to unpack the concept of "price elasticity", which is what we will start doing in the next section.