Jim’s firm increased its total revenue by lowering the price of the product by five percent...

Jim’s firm increased its total revenue by lowering the price of the product by five percent last month. This month a 5% reduction in price has lead to a decrease in total revenue. There is no reason to suspect a change in demand for the product, all the shift variables have remained constant. Please explain this confusing situation to Jim.

Expert Solution

There is a test called as total revenue test which explains that:

If price elasticity of demand is more than 1(Elastic) then it implies that price and Total revenue will move in opposite direction.
If price elasticity of demand is less than 1(inelastic) then it implies that price and Total revenue will move in same direction.
If price elasticity of demand is equals to 1(unit Elastic) then it implies that change in price will not cause any change in Total revenue.

So in previous month, there is an elastic demand for firm's product which cause increase in total revenue due to a 5% decrease in price and in this current month, there is an inelastic demand for firm's product which cause decrease in total revenue due to a 5% decrease in price. Jim's firm should focus on change in quantity demand which is caused by change in price and it must decide what to do by considering price elasticity of demand.

Rahul Sunny answered 8 months ago

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