Question

Completely explain why a firm's total revenue will rise if it raises prices when demand is inelastic and will fall if it raises when demand is elastic.

Answer 1

Since TR=P*Q

Since the elasticity of demand can be defined as the measurement of the degree of the responsiveness of the quantity demand due to the change in the price level.

Price elasticity of demand= % change in the quantity demand/ % change in the price

If Ed is greater than 1, then the demand is elastic.

If Ed is less than 1, then the demand is elastic.

Hence it can be said that when demand is elastic, then consumers are very responsive to change in the price and vice-versa.

When demand is inelastic, then with the rise in the price, the quantity demand is less affected. So quantity demand decreases by very little amount.

So the total revenue will rise.

When demand is elastic, then with the rise in the price, the quantity demand is affected significantly. So quantity demand decreases by huge amount.

So the total revenue will fall.