Question

It is generally true that when the price of a good is increased (all else equal) the quantity demanded of that good will decline and the revenue from the sales of the good will also decline. There are exceptions, however, where price increases result in a reduction in the quantity demanded but revenue increases.

1. Explain in detail the types of situations in which the exceptions occur. Define all the relevant terms

Answer 1

When the price of a good rises, the expenditure or revenue increases. This is called the price effect. When the price of good rises, the quantity falls. This is called the quantity effect. How the revenue ultimately turns out depends o the strength of price and quantity effect. If price effect is stronger than quantity effect, then the revenue increases. This happens in the case of certain goods as follows -

1) Goods with no substitutes

There are certain goods that have no close substitutes. Thus, when price of the good rises, quantity decreases but not substantially. People have no alternative to this good. Thus, even with higher price they don;t decrease demand significantly and the revenue increases.

2) Necessity goods

There are certain goods like food, clothing which are necessity goods. These are needed for survival. even if price of these goods increase, quantity demanded does not decrease substantially and the total revenue increases.