The producer of X is contemplating a price change and has asked for your advice.

The producer of X is contemplating a price change and has asked for your advice. After some empirical investigation, you conclude that the price elasticity of demand for X is 1.25. As an economist, what would you advise the producer to do in order to raise total revenue? Would you advise him to raise prices or lower prices of good x? Why? Explain.

Expert Solution

Price elasticity of demand = % change in quantity demanded / % change in price.

If elasticity is greater than one, change in quantity demanded will be higher than change in price and if elasticity is less than one, change in quantity demanded will be less than change in price.

Here elasticity of demand is higher than one or 1.25. If producer increases the price, then decrease in quantity demanded will be higher than increase in price. And if producer decreases the price, then increase in quantity demanded will be higher than decrease in price.

We can conclude that when elasticity is more than one -

1) Increase in price will decrease total revenue and decrease in price will increase total revenue.

When elasticity is less than one-

Increase in price will increase total revenue and decrease in price will decrease total revenue.

When elasticity is equal to one-

Increase or decrease in price does not affect the total revenue.

So i would like to advice to decrease the price in order to increase the total revenue because elasticity is higher than one, decrease in price will increase the quantity demanded more than decrease in price and total revenue will increase.

Rahul Sunny answered 2 years ago

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