Elasticity, Total Revenue, and
Demand
The Use of Price Elasticity of
Demand
Why Elasticity matters?
Elasticity, Total Revenue, and
Demand
• If ED is elastic (ED > 1), a rise in price
lowers total revenue.
• The elasticity of demand tells suppliers
how their total revenue will change if their
price changes.
• Total revenue equals total quantity sold
multiplied by price of good.
Elasticity, Total Revenue, and
Demand
• If ED is unit elastic (ED = 1), a rise in price
leaves total revenue unchanged.
• Price and total revenue move in opposite
directions.
1
Elasticity, Total Revenue, and
Demand
Elasticity and Total Revenue
• If ED is inelastic (ED < 1), a rise in price
increases total revenue.
Unit Elastic Demand
E=1
TR constant
$10
8
F
6
Price
• Price and total revenue move in the same
direction.
Inelastic Demand
E<1
TR rises if price increases
$10
A
$10
8
TRG = $1 x 9 = $9
TRH = $2 x 8 = $16
6
Gained
revenue
4
Lost
revenue
H
2
A
0
1
2
B
3
4
5
6
7
8
9
Quantity
2
B
3
4
5
6
7
8
9
Quantity
6
Elastic Demand
E>1
K
J
C
A B
4
0
TR falls if price increases.
TRJ = $8 x 2 = $16
TRK = $9 x 1 = $9
Gained
revenue
Lost
revenue
2
G
C
1
Lost
revenue
Elasticity and Total Revenue
Price
Price
8
E
4
0
Elasticity and Total Revenue
Gained revenue
C
2
TRE= $4x6=$24
TRF= $6x4=$24
1
2
3
4
5
6
7
8
9
Quantity
2
Total Revenue Along a Demand
Curve
0
TR
decreases
Q0
<1
Quantity
Q0
Quantity
Elasticity of Individual and
Market Demand
Relationship Between Elasticity
and Total Revenue
Elastic (ED > 1)
ED = 1
Inelastic ED
0
Price Rise
>1
Total revenue
Total
Revenue
Along a
Demand
Curve
• With elastic demand – a rise in price
lowers total revenue.
• With inelastic demand – a rise in price
increases total revenue.
Price
Elastic ED
• Price discrimination occurs when a firm
separates the people with less elastic
demand from those with more elastic
demand.
Price
Decline
TR
increases
Unit Elastic (ED
TR constant TR constant
= 1)
Inelastic (ED <
TR
TR increases
1)
decreases
7-11
3
Elasticity of Individual and
Market Demand
• Firms that price discriminate charge more
to the individuals with inelastic demand
and less to individuals with elastic
demands.
Elasticity of Individual and
Market Demand
• Examples of price discrimination include:
– Airlines’ Saturday stay-over specials.
– The phenomenon of selling new cars.
– The almost-continual-sale phenomenon.
4