Question

Suppose you are in charge of sales at a pharmaceutical company, and your firm has a new drug that causes bald men to grow hair. Assume that the company wants to earn as much revenue as possible from this drug. If the elasticity of demand for your company’s product at the current price is 1.4, would you advise the company to raise the price, lower the price, or to keep the price the same? What if the elasticity were 0.6? What if it were 1? Explain your answer.

Answer 1

Relationship between total revenue and elasticity of demand -

1. If demand for a good is elastic then increase in prices leads to fall in total revenue and decrease in price leads to rise in total revenue.

2. If demand for a good is inelastic then increase in prices leads to rise in total revenue and decrease in price leads to fall in total revenue.

3. If demand for a good is unit elastic then any change in price (either increase or decrease) will have no impact on the total revenue.

CASE 1

If elasticity of demand at current price is 1.4 then this implies that demand is elastic.

In such case, in order to raise total revenue, company should lower the price.

CASE 2

If elasticity of demand at current price is 0.6 then this implies that demand is inelastic.

In such case, in order to raise the total revenue, company should raise the price.

CASE 3

If elasticity of demand at current price is 1 then this implies that demand is unit elastic.

In such case, change in price will have no impact on total revenue.

In such case, company should keep the price the same.