Question

Discuss Pricing and Elasticity as it relates to Total Revenue.

• What decisions does price elasticity allow firms to make regarding the pricing of its products?
  
• When does the firm raise prices?
  • Lower prices?
  • Give examples of goods that are perfectly inelastic, explain why?
  • Give examples of goods that are perfectly elastic, explain why?
    
• What is peculiar about unit elasticity?

Answer 1

1.Pricing and Elasticity -

Price Elasticity is a measure of the relationship between a change in the quantity demanded of a particular good and a change in its price. Price Elasticity of Demand (PED) is a term used in economics when discussing price sensitivity. The formula for calculating price elasticity of demand is:

Price Elasticity of Demand = % change in Quantity Demanded / % Change in Price

   If a small change in price is accompanied by a large change in quantity demanded, the product is said to be elastic (or responsive toprice changes). On the other hand, a product is deemed inelastic if a large change in price is accompanied by a small amount of change in quantity demanded.

Relates to the Total Revenue -

The total revenue test is a means for determining whether demand is elastic or inelastic. If an increase in price causes an increase in total revenue, then demand can be said to be inelastic, since the increase in price does not have a large impact on quantity demanded.

Price elasticiy(e) and Total Revenue(TR) -

  If with increase in price total revenue decreases and with fall in price total revenue increases, elasticity will be greater than one i.e., demand of such goods will be elastic in nature

  If with increase in price total revenue increases and with fall in price total revenue decreases, elasticity will be less than one i.e., demand of such goods will be inelastic in nature.If with change in price total revenue remains unchanged, elasticiy willbe equal to one, i.e unit elasticiy of demand. Demand curve in this case will be rectangular hyperb

Firm Raise Prices, Lower prices -
  

The decision to raise or lower prices is a tough one, with many ramifications for your business. But the decision whether or not to change prices is not as important as the decision about how to accomplish the change. To put it another way, two companies who change prices on the same products by the same amount may get widely different results depending on how they implement the new policy.

Raising and lowering prices effectively involves careful attention to timing. It requires knowing how to affect your customers' perception of the value inherent in what you are selling. It forces you to study and accurately predict reactions from your competitors.