Relationship between demand elasticity and total revenue

The Relationship Between Price Elasticity & Total Revenue |

relationship between demand elasticity and total revenue

The Relationship Between Price Elasticity & Total Revenue Price elasticity of demand = Percentage change in demand ÷ Percentage change. In economics, the total revenue test is a means for determining whether demand is elastic or Mathematical explanation[edit]. The mathematical link between them comes from the formula of the price elasticity of demand: E d = − ((Q 2 − Q 1). Total Revenue (TR) and Elasticity (With Diagram) It may be recalled that the demand for a commodity is said to be price elastic if total revenue increases (falls ) as price increases (falls). And if TR remains Relation among TR, MR & Ep.

relationship between demand elasticity and total revenue

Try F on your own. My quantity is 16 burgers per hour. I sell a total of 32 burgers.

relationship between demand elasticity and total revenue

Now actually, let's just do the last one, F, just to feel a sense of completion. 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.

Total revenue test

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. And this is 20 right over here. And then total revenue. Let's see, it gets as high-- it gets pretty close to This is 10 20, 30, 40, and So that's 50, 40, 30, 20, and So when our quantity is 2, and our price is 9.

Well, we don't have price on this axis right over here. But when our quantity is 2, our total revenues So it's going to be something like there. Then, when our quantity is 4, our total revenue is Then, when our quantity is 9, our total revenue is almost So right over there. And then, when it's 11, it's also at that same point right over there. And then, when we are quantity is 16, our total revenues And then finally, when our quantity is 18, our total revenue is And what you see is that it's plotting out a curve that looks like this.

And if you remember some of your algebra 2, this is a concave downwards parabola right over here. And you can see there was actually some point at which you could maximize your total revenue. And if you really tried all the points here, you would see that maximum point is if you tried this point right over here, right at price 5 and quantity Now, the whole reason why I'm talk think about this. I could have talked about this independently of any discussion of elasticity just to see how total revenue relates to price and quantity at different points on the demand curve.

But there is an interesting relationship. In that very first video, and we actually used this exact demand curve for it. When we explored elasticity, we saw that up here at this part of the curve-- let me do this in a different color.

relationship between demand elasticity and total revenue

At this point of the curve in orange for any change-- when you do a change in your price since the prices are pretty high, that is a much lower percent change in price than the impact that you get on quantity.

Because over here, although they look like they're close. Or I should say the absolute. For every 1 that down we move in price, we're moving 2 up quantity. But that 1 down in price is a very small percentage of price because our prices are high here.

And it's a very large percentage of quantity right over here.

Total revenue and elasticity (video) | Khan Academy

So you get huge changes in percent quantity for very small changes in price in this part of the curve. So this part of the curve is elastic. Or you could say that its price elasticity for demand is greater than 1. You get larger changes in percent quantity for a given change in percent price. Now, these parts of the curve down here, we saw is the opposite's happening.

Total revenue test - Wikipedia

You move 1 down, 1 unit down in price, you move 2 units to the right in quantity. But over here, price is a much lower. So this is a much larger percentage change in price. And this is a much smaller percentage change in quantity.

relationship between demand elasticity and total revenue

So you get large percentage changes in price for small percentage change in quantity. That means that here, you are relatively inelastic.

And then right over here, right at this point, right in this region, right over here, we saw that we had unit-- we were unit elastic right over there.

So there's an interesting relationship going on. While we were, so while we were elastic, this part right over here, when we lowered price in this region.

While we were elastic, when we lowered price, we got increases in revenue. So let me write this down. And this is generally, too, there's a couple of boundary cases on the math that make it a little bit, you can't make it absolutely true. But while we are elastic, at the elastic points of our demand curve, a decrease in price.


Total revenue was going up. You do a price cut on this part of the demand curve, you get more revenue. Then, when you are at unit elasticity, what was happening?

relationship between demand elasticity and total revenue

At unit elasticity, you were right at this point right over here. Right at this point over here. And roughly, when you do a price cut-- and I'm going to say this is roughly true-- your total revenue stays constant. The price for oatmeal goes up, and consumers buy less of the product. They may start buying other cereal products, or they might switch to the grocery store's generic brand of oatmeal.

Factors That Affect Elasticity The factors that affect the price elasticity of any product include: As in the case of rising prices for oatmeal, consumers can shift their purchases to similar products if they are readily available.

Coca-Cola and Pepsi are products that can be easily substituted for each other when prices change. This is an example of elastic demand. If the alternatives are limited, the demand is less elastic.

The Relationship Between Price Elasticity & Total Revenue

Necessities are products that people must have regardless of the price. Everyone has to drink water, so if the water company raises prices, people continue to consume and pay for it.

  • Total revenue and elasticity
  • Total Revenue (TR) and Elasticity (With Diagram)

Luxuries are optional; they aren't necessary to live. 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.