A local merchant raises the price of his good and finds that his total revenue increased. The demand for this good is:
options:
substitute
elastic unit
elastic
inelastic
The correct answer and explanation is:
The correct answer is inelastic.
When a merchant raises the price of a good and finds that total revenue increases, it indicates that the demand for the good is inelastic. This means that the percentage change in quantity demanded is less than the percentage change in price. As a result, when the price rises, the total revenue (price multiplied by quantity sold) increases.
In an inelastic demand situation, consumers are relatively less responsive to price changes. The product is typically a necessity, has few substitutes, or represents a small portion of a consumer’s budget, making buyers less likely to reduce their quantity demanded significantly in response to a price increase.
For example, essential goods like gasoline, medications, or basic utilities often experience inelastic demand. Even if prices rise, consumers still need to purchase the product, leading to a relatively smaller decrease in quantity demanded. This price increase translates to a higher total revenue for the seller.
To explain this further, when demand is elastic, a price increase causes a larger decrease in quantity demanded, which leads to a reduction in total revenue. If demand is unit elastic, price changes do not affect total revenue, as the percentage change in price is exactly offset by the percentage change in quantity demanded.
In contrast, when demand is inelastic, the quantity demanded decreases by a smaller percentage than the price increase, resulting in a net increase in total revenue for the seller. Therefore, a price hike leads to a higher total revenue only when demand is inelastic.