Answer to Question #60159 in Microeconomics for Ethan

Question

Discuss how the knowledge of price elasticity of demand can assist firms with their pricing strategy

Answer 1

The main purpose of pricing strategy of any firm is to maximize revenues.
By definition, total revenue (TR) is obtained by multiplying quantity demanded of a product (Qx) by price (Px), that is
TR=Q×P

If Ep = 1.0, a change in price will have no effect on total revenue.
If Ep > 1 demand is price elastic, and even a slight decrease in prices leads to a significant increase in sales. So, total revenue increases. A increase in price will have the opposite effect on total revenue. The relationship between price and total revenue is negative. Consequently, in that case the firm has to decrease it's prices.
If Ep< 1 demand is price inelastic, and the relationship between price and total revenue is positive. That is, an increase in price will have the effect of increasing total revenue and a decrease in price will cause a decline in revenue. Consequently, in that case the firm has to increase it's prices.