Explain price elasticity and total revenue, Managerial Economics

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Q. Explain Price elasticity and total revenue?

Given the relationship between price elasticity and marginal revenue of demand in Eq. II, the decision-makers can simply know whether or not it is advantageous to change the price. Given Eq. II, if e = 1, MR = 0. Thus, change in price won't cause any change in TR. If e < 1, MR < 0 and, therefore TR decreases when price decreases and TR increases when price increases. And if e > 1, MR > 0, then TR increases if price decreases and TR increases when price increases.

Effect of change in price on TR for different price-elasticity co-efficient is summarised in the table mentioned below:

Table: Elasticity, Price change and change in TR

Elasticity Demand

Nature of Price

Change in TR

Change in co-

efficient

ep = 0

Perfectly inelastic

Increase 

Decrease

Increases 

Decreases

ep< 1

Inelastic

Increase 

Decrease

Increases 

Decreases

ep = 1

Unitary elastic

Increase 

Decrease

No change in TR

ep> 1

Elastic

Increase 

Decrease

Decrease 

Increases

ep = ∞

Infinitely elastic

Increase 

Decrease

Decrease to zero

Increase infinitely

As the table illustrates, when e = 0, the demand is said to be perfectly inelastic. Perfect inelasticity of demand implies no change in quantity demanded when price is changed. So, a rise in price will increase the total revenue and vice versa. In the case of an inelastic demand (which means, e < I), quantity demanded increases less than the proportionate decrease in price and henceforth the total revenue falls when price falls. Total revenue increases when price increases since quantity demanded decreases less than proportionately. If demand for a product is unit-elastic (e = 1) quantity demanded increases (or decreases) in the proportion of decrease (or increase) in the price. Then, the total revenue remains unaffected. If demand for a commodity has e > 1, change in quantity demanded is greater than proportionate change in price. Consequently, the total revenue increases when price falls and vice versa. The case of an infinitely elastic demand is rare. Such a demand line basically implies that a consumer has the opportunity of buying any quantity of a commodity and seller can sell any quantity of commodity, at a given price: it's the case of a commodity being bought and sold in a perfectly competitive market.


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