Understanding Price Increase and Expenditure
When the price of a commodity increases, it affects consumer expenditure based on the price elasticity of demand (ED). In this scenario, the price rises by 12%, and the price elasticity of demand is -0.63.
Price Increase Impact
- A 12% increase in price indicates that consumers will pay more for the same quantity of the commodity.
Price Elasticity of Demand (ED)
- The ED of -0.63 suggests that the demand for this commodity is inelastic.
- This means that for every 1% increase in price, the quantity demanded decreases by 0.63%.
Calculating Change in Quantity Demanded
- With a 12% price increase, we can calculate the change in quantity demanded:
- Change in quantity demanded = 12% * -0.63 = -7.56%
- This indicates that consumers will reduce their quantity demanded by approximately 7.56%.
Expenditure Analysis
- Expenditure (E) can be calculated as:
- E = Price (P) x Quantity (Q)
- After the price increase, if the original price is P and quantity is Q, the new price becomes 1.12P, and the new quantity demanded becomes approximately 0.9244Q (100% - 7.56%).
Final Expenditure Calculation
- New Expenditure (E') = New Price x New Quantity
- E' = (1.12P) x (0.9244Q) = 1.035P x Q
- This indicates that the new expenditure will be approximately 103.5% of the original expenditure.
Conclusion
- Despite the price increase, the inelastic demand means that the overall expenditure on the commodity will rise, reflecting the reduced quantity demanded but higher price.