Total Expenditure Test

Have you ever wanted to buy more of something just because its price dropped? Let's say you've been buying an apple a day for $2 for the past month. News came in that the price of an apple has been reduced to $1. Suddenly, you start buying $3 worth of apples a day. What happened? Well, it means your demand for apples is price elastic. The total expenditures test is concerned with checking just how price elastic your demand for apples is. Read on for a total expenditure Test definition, the formula, and more!

Elasticity of Demand Total Expenditure Test

The total expenditures test is used to determine the elasticity of demand for a particular product. In other words, it checks the price elasticity of demand of a given product.

Wait, let's not move too fast here. What is the price elasticity of demand in the first place? When there is a change in price of a product, consumers often react by changing their quantity demanded of that product. In other words, when the price of a product changes, consumers respond by changing how much of that product they're willing and able to buy at any point.

However, it is important to note that consumers will react differently to the price changes of different products. For instance, they may buy more apples when the price of apples goes down, but they may not change the number of painkillers they buy even if the price of painkillers goes down. Price elasticity of demand, therefore, refers to how much quantity demanded changes as a result of a change in price.

Demand can be elastic, inelastic, or unit elastic. Let's look at what these three mean.

Elastic demand and the total expenditures test

Elastic demand describes a situation where a change in price results in a relatively larger change in quantity demanded.

Figure 1. Elastic Demand, StudySmarter Originals

Figure 1 above shows elastic demand. Looking at Figure 1, you can see that the distance from P1 to P2 (change in price) is smaller when compared to the distance between Q1 and Q2 (change in quantity demanded). This shows the concept of elastic demand. The small change from P1 to P2 resulted in a larger change from Q1 to Q2.

Inelastic demand and the total expenditures test

For inelastic demand, a change in price results in a relatively smaller change in quantity demanded.

Figure 2. Inelastic Demand, StudySmarter Originals

Figure 2 above shows inelastic demand. Looking at Figure 2, you can see that the change in price shown by the distance from P1 to P2 is larger when compared to the change in quantity demanded or distance between Q1 and Q2. From this, we can conclude that a change in price caused a smaller change in quantity demanded, therefore, this is inelastic demand.

Unit elastic demand and the total expenditures test

In some cases, a change in price results in an equally proportional change in quantity demanded, and this is referred to as unit elastic demand.

Figure 3. Unit Elastic Demand, StudySmarter Originals

Look at Figure 3 for an illustration of unit elastic demand. Figure 3 shows that the change in price or the distance from P1 to P2 is proportional to the change in quantity demanded or the distance between Q1 and Q2. This shows unit elastic demand.

Total Expenditures Test Definition

What is the definition of the total expenditures test? The total expenditures test determines the demand elasticity of a given product. Economists look at how much the total expenditure has changed when price changes, and this informs us about the demand elasticity of the product we are looking at.

Total Expenditure Test: Total expenditure formula

Total expenditure is calculated by multiplying the price by the quantity demanded. Economists use the following formula:

\(\hbox{Total Expenditure}=\hbox{Price (P)}\times\hbox{Quantity Demanded (Q)}\)

Total expenditure can also be referred to as what consumers spend on a product at a given price. Let's look at a simple example.

Explain the Purpose of the Total Expenditures Test

The purpose of the total expenditures test helps economists determine the price elasticity of demand for a product. We do this by looking at the effect of a price change on the total expenditure. In other words, how did the total expenditure change when the price changed?

So, how exactly can one use the total expenditures test to determine the demand elasticity of a product? Follow three simple rules!

• The first rule is that if the total expenditure reduces when the price increases, the demand for a good is price elastic.

  In contrast, if the total expenditure increases when the price decreases, the demand for a good is price elastic. In other words, if they go opposite ways, the demand for a good is price elastic.

• The second rule is that if the total expenditure reduces when the price decreases, the demand for a good is price inelastic.

  In contrast, if the total expenditure increases when the price increases, the demand for a good is price inelastic. In other words, if they go the same way, the demand for a good is price inelastic.

• The third rule is that if the total expenditure does not change when the price changes, the demand for a good is unit elastic.

Let's try our hand on an example now.

Total Expenditure Example

Now, let's try another example where we find the total expenditure and the elasticity of demand.

Great! You finished this topic. You should read our article on the Elasticity of Demand, it goes deeper into how demand elasticity works!