Question

Over 15 Million Households Plan To Ration Energy Use This Winter to Cope With Soaring Bills The cost of energy is rising and British consumers are left to cope with a harsh winter. Seeing their energy bills rise, millions of households are planning to cut back as much as they can on their energy use despite the cold temperature, putting their health at risk. Many bill payers will cope by spending less on food so that they can afford to keep their homes warm. Household disposable income has been substantially affected by rising energy costs and prices are expected to keep increasing. Some estimate that the average UK home will spend \(£ 53\) more on energy this year. Source: This is Money, November 6,2014 a. List and explain the elasticities of demand that are implicitly referred to in the news clip. b. Why, according to the news clip, is the demand for energy inelastic?

Short answer

Energy demand is inelastic because it is a necessary good with few substitutes, and households continue to consume it even as prices increase.

Step-by-step solution

Understand Elasticities of Demand

Elasticity of demand measures how much the quantity demanded of a good responds to a change in price. There are different types of elasticities such as price elasticity of demand, income elasticity of demand, and cross-price elasticity of demand.

Identify Elasticities in the News Clip

In the news clip, two types of elasticities are implicitly referred to: 1. Price Elasticity of Demand: This is indicated as households are planning to cut back on energy usage (quantity demanded) due to the rising energy bills (prices). 2. Income Elasticity of Demand: This is indicated as household disposable income is affected, meaning changes in income level are impacting the demand for energy.

Explain the Elasticities

1. Price Elasticity of Demand (PED) refers to the responsiveness of the quantity demanded of a good to a change in its price. The news mentions households will limit energy usage in response to rising prices, implying that energy has a significant price elasticity of demand. 2. Income Elasticity of Demand (YED) refers to the responsiveness of the quantity demanded of a good to a change in consumer income. The news clip indicates that as disposable income decreases, households will allocate less to energy, showing the outlay on energy is sensitive to changes in income.

Discuss Inelastic Demand

Demand for a good is considered inelastic if the quantity demanded does not change significantly in response to price changes. According to the news clip, households are still willing to spend on energy despite the rising cost because energy is a necessity, especially in winter. Essential goods like energy have fewer substitutes and are less sensitive to price changes, hence exhibiting inelastic demand characteristics.

Conclude Why Energy Demand is Inelastic

The news clip implies that energy demand is inelastic because it is a necessary good, particularly in winter when it's essential for heating. People cannot easily find substitutes or forgo its use without significant lifestyle or health impacts, hence they continue to consume energy even as prices rise.

Key concepts

price elasticity of demand

Price elasticity of demand (PED) measures how the quantity demanded of a good changes in response to price variations. In this context, if energy prices rise, how much will the consumption of energy decrease? Typically for energy, the PED is low, meaning that even with higher prices, the drop in consumption isn’t as significant as for luxury items. This implies that consumers still need to use energy for essential activities like heating during winter, despite the price hike. Households in the news clip plan to reduce energy use due to rising costs, showcasing PED in action.

income elasticity of demand

Income elasticity of demand (YED) refers to how sensitive the demand for a good is with respect to changes in consumer income. When household disposable income decreases, as noted in the news clip, the amount of money available to spend on various goods, including energy, reduces. This relationship is crucial, particularly here, as rising energy costs lower disposable income. Households must then decide how to allocate their funds, often cutting back on other expenditures to maintain essential energy consumption.

inelastic demand

Demand is considered inelastic if it doesn’t significantly change with price alterations. In the case of energy, as illustrated in the news clip, even though prices rise, people's need to stay warm during winter forces them to continue purchasing energy. Energy is a necessity, and for many, there are few alternatives. Hence, inelastic demand denotes that despite rising costs, the quantity demanded remains relatively stable, underscoring its essential nature.

household disposable income

Household disposable income is the amount of money households have available for spending and saving after taxes are deducted. Rising energy costs effectively reduce this income, as more money is spent on maintaining essential energy usage. This affects overall economic behavior as households adjust their spending. For instance, the news clip mentions some may cut back on food to ensure they can afford energy, highlighting the strain on their limited disposable income.

necessity goods

Necessity goods are items that are essential for daily life. Energy, especially in winter for heating, falls into this category. Unlike luxury goods, necessity goods have inelastic demand because consumers cannot easily reduce or substitute their consumption even if prices rise significantly. The news clip discusses the high importance of energy during cold weather, underlining that even with soaring bills, households must continue to purchase energy, demonstrating the critical nature of necessity goods.