The price elasticity of demand is a measure of how much the demand for a product

Question

The price elasticity of demand is a measure of how much the demand for a product is affected by a change in price. Review the following scenario and answer the questions that follow.

Evelyn makes $15,000 per year and Tami makes $150,000 per year. They are both buying roast beef at the grocery store. Evelyn asks for $10 worth of roast beef, and Tami asks for 10 pounds of roast beef.

What is each consumer’s price elasticity of demand?

Identify examples of situations that would affect the marginal utility of roast beef for each consumer. Explain how each consumer’s marginal utility of roast beef would be affected by each factor

Explanation / Answer

Evelyn makes $15,000 per year and asks for $10 worth of roast beef. It implies she does not care about how much she will be consuming (change in quantity can be large or small), what she cares about is the expenditure and so she buys it for a fixed expenditure of $10. If price of beef falls, her quantity will rise only enough so that she has same spending. This can happen only when elasticity is 1.

Note that this is true because if price rises by 10%, consumption falls by 10% so that spending amount is unchanged at $10. Hence price elasticity is unitary elastic.

Tami makes $150,000 per year and asks for 10 pounds of roast beef for any price. Hence her demand is perfectly inelastic and this means price elasticity is 0.

There will be no addition to the utility to Tami because she buys fixed unit of beef so that any additional unit of beef gives 0 utility. Evelyn can have a increased utility (positive marginal utility) because her consumption can increase. The factors that affect her decision are her income, price of substitutes and complements, number of people buying it and share in her budget.

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