Relationship between price elasticity of demand and total revenue

relationship between price elasticity of demand and total revenue

The Relationship Between Price Elasticity & Total Revenue Price elasticity of demand = Percentage change in demand ÷ Percentage change. Elastic Demand and Total Revenue. Elastic Demand: Elasticity > 1. Percentage change in quantity is greater than percentage change in price. Raise Price. The relationship between elasticity of demand and a firm's total revenue is an important one.

And when I talk about revenue, for simplicity, let's just think that's really just how much total sales will I get in a given hour. So let me just write over here total revenue. Well, the total revenue is going to be how much I get per burger times the number of burgers I get. So the amount that I get per burger is price. So it's going to be equal to price. And then the total number of burgers in that hour is going to be the quantity.

Now, let's think about what the total revenue will look like at different points along this curve right over here. And actually, let me just make a table right over here.

relationship between price elasticity of demand and total revenue

So I'll make one column price, one column quantity. And then let's make one column total revenue.

Total revenue test - Wikipedia

So let's look at a couple scenarios here. Well, we could actually look at some of these points that we already have defined. At point A over here, price is 9. So I'll do it in point A's color. And you can see it visually right over here. This height right over here is 9. And this width right over here is 2. And your total revenue is going to be the area of this rectangle. Because the height is the price.

And the width is the quantity.

  • Total revenue and elasticity
  • The Relationship Between Price Elasticity & Total Revenue

So that total revenue is the area right over there. Now, let's go to point-- let me do a couple of them just to really make it clear for us. Let's try to point B. So at point B when our price is 8 and our quantity is 4, 4 per hour. And once again, you can see that visually. The height here is 8.

And the width here-- so the height of this rectangle is 8. And the width is 4. The total revenue is going to be the area. It's going to be the height times the width just like that. Now, let's go to a point that I haven't actually graphed here. Actually, let me just-- actually, I'll go through all the points just for fun.

Total revenue and elasticity (video) | Khan Academy

So now at point C, we have 5. The quantity is 9. And you have another 4. So that is So once again, it's going to be the area of this rectangle. Area of that rectangle right over there. So you might already be noticing something interesting.

As we lower the price, at least in this part of our demand curve, as we lower the price, we are actually increasing not just the quantity were increasing the total revenue.

Price Elasticity & Total Revenue

Let's see if this keeps happening. So if we go to point D, I'll do it in that same color. And we are selling 11 units. So 11 times 4. Let's see, this is going to be 44 plus 5.

Once again, that is So that this rectangle is going to have the same area as that pink one that we just did for scenario C. And I'll actually just do one more down here, just to see what happens. Because this is interesting. Now we lower the price. And it looks like things didn't change much.

And now, let's go-- let's just do one more point actually for the sake of time. And I encourage you to try other ones. Try F on your own.

My quantity is 16 burgers per hour. I sell a total of 32 burgers. Now actually, let's just do the last one, F, just to feel a sense of completion.

relationship between price elasticity of demand and total revenue

I sell 18 burgers per hour. And once again, that's the area of this rectangle, this short and fat rectangle right over here. And E was the area-- the total revenue in E was the area of that right over there.

And you could graph these just to get a sense of how total revenue actually changes with respect to price or quantity. Lets plot the total revenue with respect to quantity. So let's try it out. So if you-- let me plot it out. So this is going to be total revenue.

And this axis right over here is going to be quantity. And we're going to, once again, go from-- let's see.

relationship between price elasticity of demand and total revenue

And this is 20 right over here. Necessities are products that people must have regardless of the price.

Total revenue test

Everyone has to drink water, so if the water company raises prices, people continue to consume and pay for it. Luxuries are optional; they aren't necessary to live.

relationship between price elasticity of demand and total revenue

Large-screen HDTVs are nice to have, but if the prices go up, consumers can put off buying them. Share of the consumer's income: Products that consume a high proportion of a family's income are sensitive to price increases.

A car is a good example. Increases in car prices can cause a family to delay purchasing a new car. They keep their old car longer and make the necessary repairs. However, if a grocery store increases the price of toothpicks, consumers still buy them because the price isn't a big piece of their income. Short-term versus long-term timing: Gasoline is an excellent example of a product that prices inelastic in the short term but elastic in the long term.

When gas prices go up, the consumer still has to buy gas to get to work. However, if gas prices stay high for the long term, consumers make changes. They may buy more fuel-efficient cars, set up a carpool with other workers, or start taking a train or bus to work. Why Elasticity Is Important Marketers must have some knowledge about the elasticity of their products to set pricing strategies.

If marketers know that the demand for their products is inelastic, then they can raise prices without fear of losing sales. On the other hand, if demand for their products is highly elastic, then raising prices could be a dangerous game. The relationship between price elasticity and total revenue is an important metric for marketers to understand. Understanding whether the price of a product is elastic or inelastic is essential for a company to develop an effective marketing campaign and survive in the marketplace.

Price elasticity is a tool that marketers can use against their competitors to increase their share of a market.