3.6 Elasticity and Total Revenue
Notes
Total revenue is the money a seller receives: $TR = P \times Q$. Elasticity tells a seller how a price change will affect total revenue.
| If demand is | Raising price | Lowering price |
|---|---|---|
| Elastic ($E_d > 1$) | total revenue falls | total revenue rises |
| Inelastic ($E_d < 1$) | total revenue rises | total revenue falls |
| Unit elastic ($E_d = 1$) | total revenue unchanged | total revenue unchanged |
- With elastic demand, the percent drop in quantity is bigger than the percent rise in price, so revenue falls.
- Worked example: the theater in 3.5 earned $10 \times 500 = 5{,}000$ dollars before the price rise and $12 \times 350 = 4{,}200$ dollars after. Revenue fell, as expected for elastic demand.
- This is why businesses selling goods with inelastic demand can raise prices without losing much revenue, and why sellers of elastic goods often hold sales.
Practice
A juice stand sells 120 cups a day at $2. It raises its price to $3 and sells 100 cups. What happened to total revenue, and what does this suggest about demand?
$2 \times 120 = 240$ and $3 \times 100 = 300$. Revenue rising after a price increase signals inelastic demand.
A company's product has elastic demand. To increase total revenue, it should:
With elastic demand, the gain in quantity sold outweighs the lower price.
If demand for a good is unit elastic, a $10\%$ price increase will cause total revenue to:
Quantity falls by the same percentage the price rises, so revenue is about unchanged.
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