Answer to Question #217799 in Microeconomics for Khwisti

Question

illustrate 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

When demand is elastic i.e., price elasticity > 1, there is a negative relationship between price and total revenue  meaning price increases leads to reduction in total revenue. When the demand is unitary elastic, i.e.,  price elasticity = 1, changes in prices  does not affect total revenue.

 Incase the demand is elastic at a particular level of price, incase a company reduces its price, the percentage price drop in price results in greater percentage increase in the sold quantity sold raising total revenue.

If the good is elastic, the effect of quantity outweighs the effect of price, meaning if prices decrease, the gained revenue from the marginal units sold outweighs the lost revenue from the price decrease.

If the good is inelastic the effect of price outweighs the effect of quantity, meaning if prices increase, the gained revenue from the higher price outweighs the lost revenue from less units sold.