Answer to Question #218388 in Macroeconomics for Timza

Question

As a Production Manager of a manufacturing firm that produces both an elastic good and an inelastic good, illustrate to a new board of the organisation the relationship between price elasticity of demand and total revenue, and how the elasticity concept can be used to maximise revenues of both commodities? Illustrate your answer using relevant diagrams of elastic and inelastic goods.     

Answer 1

Price elasticity of demand describes how changes in the price for goods and the demand for those same goods relate. As those two variables interact, they can have an impact on a firm's total revenue. Therefore, as the price or the quantity sold changes, those changes have a direct impact on revenue.

If demand is elastic at a given price level, then should a company cut its price, the percentage drop in price will result in an even larger percentage increase in the quantity sold—thus raising total revenue.

If the price for an inelastic good is lowered, the demand for that good does not increase, resulting in less overall revenue due to the lower price and no change in demand. This would indicate that the firm should not reduce the price of its goods as there is no beneficial outcome in doing so.