Question

Discuss the relationship between elasticity and total revenue.

Answer 1

1) When elasticity of demand is inelastic (that is when percentage change in quantity demanded is less than the percentage change in price) - a rise in price leads to a rise in total revenue and a fall in price leads to fall in total revenue. That is , there is a positive relationship between price changes and total revenue changes when demand is inelastic.

Eg.- suppose initial price is $10 and initial quantity is 100 units.

For inelastic - suppose now , price increases by 10% , new price = 11 and quantity falls by 5% , new quantity = 95.

So initial total revenue = 10 x 100 = 1000

New total revenue = 11 x 95 = 1045. Total revenue increases when price increases , given demand is inelastic.

2) When elasticity of demand is elastic (that is when percentage change in quantity demanded is greater than the percentage change in price) - a rise in price leads to a fall in total revenue and a fall in price leads to a rise total revenue. That is , there is an inverse relationship between price changes and total revenue changes given that the elasticity of demand is elastic.

Eg.- suppose initial price=$10 and initial quantity =100 units

With elastic demand , suppose price rises by 10% to $11 , then quantity demanded will have to fall by more than 10% as demand is elastic. So lets suppose demand falls by 15% to 85 units.

Now , initial total revenue = 10 x 100 = 1000

New total revenue = 11 x 85 = 935.

Therefore , with elastic demand , as price rises total revenue falls. That is there is an inverse relationship

3) When elasticity of demand is unit elastic then the as the rises or falls , total revenue remains the same that is constant.