How the price elasticity of demand affects the total revenue?
Total revenue is the sum of all products and services sold. It is computed by multiplying the total number of products and services sold by their pricing. Demand curves give us the required information about how consumer response changes with the change in price for which economists use the phenomena of elasticity of demand which tell how sensitive the consumer’s decisions are to change in price. Suppliers use the elasticity of demand to calculate their total revenues by understanding how the price changes affect the demanded quantity.
Total Revenue:
Revenue is the amount of money a supplier generates by selling his or her goods or services. It could be calculated by multiplying the price of goods or services by the quantity they sell.
TR = P * Q
This could better be understood through graphical representation as shown below. As the demand curve represents the amount the consumer is willing and able to buy at a particular price so for calculating the revenue takes any point on the demand curve. This point represents how much the supplier would be able to sell at that price. So let suppose we select the point at which price is Rs. 150 and quantity demanded by consumer is 25 units as shown on the graph. So according to the formula of revenue pice into the quantity, the total revenue of the supplier would be 3750 (150*25). Graphically it is represented by the rectangular shaded area. As we know the formula for the area of the rectangle is (length* width) so here we can see that our length is 150 and width is 25. So if we have to find the total revenue through the graph we can use the formula of area of a rectangle.
Now we will see how the total revenue changes in elastic and inelastic demand curves.
Elastic Demand:
The goods or services which show elastic demand curves their revenues increase with a decrease in prices. With a decrease in price, even suppliers would earn less revenue per unit but the extra units that they sold would cover the loss.
Considering the graph shown below would help us to understand the situation better. As we can see at Rs. 150 total revenue is 3750 (150*25) which is represented by the purple and brown area. Now as the price goes down to Rs.100 and total revenue becomes now 7500 (100*75) it means as the price decreases the quantity demanded increases and hence the total revenue. Revenue increase because the loss they faced by decreasing the prices is applied to only 25 units and this loss is equal to 1250 (25*50) which is represented by the purple area but the gain they get by selling the 75 units at Rs. 100 is 7500 which is represented by the green and brown areas and this area is clearly larger. So as the gain is greater than loss so that’s why revenue increases by Rs.6250 (Rs.7500 – Rs.1250). This is the reason why cloth brands have sales.
Inelastic Demand:
In inelastic goods or services, the price and total revenue have direct relations. As the prices go down so does the revenue and as the prices go up so does the revenues. In the case of the inelastic demand curve as the prices go down the demand increases but not that much that they could cover the loss for the decrease in prices.
Considering the graph shown below would us help to understand the situation better. As we can see at Rs. 100 total revenue is 2000 (100*20) which is represented by the purple and brown area. Now as the price goes down to Rs.50 so the total revenue becomes now 1500 (50*30) it means as the price decreases the quantity demanded increases but with little amount and hence the total revenue is not that much as in the case of a higher price. So that’s why gas stations don’t have sales because the demand for gasoline is inelastic so having sales and decreasing prices would not increase the revenues.
Also Read: Price Elasticity Of Demand
