How do you advise consumers to spend wisely by using the concept of price elasticity of demand? What are some illustrations and examples?

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pnrjulius eNotes educator| Certified Educator

The price elasticity of demand is, for a given product and a given consumer, how much the quantity they would like to purchase changes for any given change in price. For example, if a 1% increase in price causes them to want to buy 2% less of the good, their price elasticity of demand would be -2%.

If a good has a high elasticity, we say it is elastic; this means that consumers are very sensitive to changes in price, and a small increase in price will cause them to buy a lot less. The most elastic goods are usually things like movies and restaurant meals that are luxuries people can do without if they get too expensive.

If a good has a low elasticity, we say it is inelastic; this means that consumers are insensitive to changes in price, and a large increase in price will only cause them to buy a little less. The most inelastic goods are usually things like food and medicine that are necessities people need to have no matter what.

As far as advising consumers, a heuristic I try to teach most people is "cheap expensive things, expensive cheap things"; there's a tendency for people to think of a 1% increase in price as more or less the same thing across a wide class of goods---meaning that they essentially try to equalize their price elasticity of demand across different goods. But a 1% increase in the price of a car is a much larger financial commitment than a 1% increase in the price of a toothbrush---indeed, a 1% increase in the price of a car is a larger expenditure than a 1000% increase in the price of a toothbrush! By this heuristic I'm essentially trying to tell people to be more elastic about expensive goods like cars, and less elastic about cheap goods like toothbrushes.

Another heuristic one might use is to try to be more elastic in general, which will generally lead to you spending less money; but that's only optimal if you really aren't getting that much benefit from those goods and really should have avoided buying so many all along. If you artificially force yourself to purchase less than you really want, you'll spend less money, but ultimately harm yourself because you aren't using money for what it's for---which is to make people's lives better.

It's also important to understand that "more elastic" isn't the same as "buy less"; in the attached diagram, the green demand curve is much more elastic than the blue demand curve. Along the bright red supply curve, these two consumers purchase the same amount of goods at the same price. But as the supply curve moves up and down, the green consumer responds more strongly to price changes in both directions---as goods get more expensive, they buy a lot less, and as they get cheaper, they buy a lot more.

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