If demand is elastic, then
Group of answer choices
a decrease in price will have no effect on total revenue
an increase in price will increase total revenue
a decrease in price will reduce total revenue
an increase in price will reduce total revenue
The Correct Answer and Explanation is :
Correct Answer:
An increase in price will reduce total revenue.
Explanation:
Elasticity of demand measures how much the quantity demanded of a good responds to a change in price. When demand is elastic, it means that the quantity demanded is highly responsive to price changes. This occurs when the price elasticity of demand (PED) is greater than 1 (|PED| > 1), meaning a small percentage change in price results in a larger percentage change in quantity demanded.
Impact on Total Revenue
Total revenue (TR) is calculated as:
[
TR = \text{Price} \times \text{Quantity}
]
- If demand is elastic, consumers are very sensitive to price changes.
- When price increases, the decrease in quantity demanded is proportionally larger than the increase in price, leading to an overall drop in total revenue.
- When price decreases, the increase in quantity demanded is proportionally larger than the decrease in price, leading to an overall increase in total revenue.
Example Scenario
Consider a product with elastic demand, such as luxury goods or restaurant meals. Suppose a restaurant raises the price of a meal from $10 to $12:
- If demand is elastic, many customers will stop dining there or reduce their visits.
- The loss in customers is greater than the increase in price per meal.
- As a result, the restaurant’s total revenue falls.
Thus, when demand is elastic, increasing prices reduces total revenue, while decreasing prices increases it.
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However, you can visualize the concept using a simple graph:
- Draw a downward-sloping demand curve labeled “Elastic Demand.”
- Mark a point where the price increases, showing a sharp drop in quantity demanded and a decrease in total revenue.
- Mark another point where the price decreases, illustrating a significant increase in quantity demanded and an increase in total revenue.