Understanding Price Elasticity and Total Revenue for Producers

1. What is Price Elasticity?

Price elasticity looks at how people buy things when prices change. For producers, knowing about elasticity helps them decide the best prices to make the most money.

• Elastic Demand:

  This happens when a small price change causes a big change in how much people buy.

  For example, if a company lowers the price of smartphones by 10% and sales go up by 20%, we can calculate price elasticity like this:

  Price Elasticity of Demand = (Change in Quantity Demanded) / (Change in Price)

  So, it would be:

  $\text{Price Elasticity} = \frac{20\%}{-10\%} = -2$

• Inelastic Demand:

  This is the opposite. If people still buy almost the same amount when prices rise, we say demand is inelastic.

2. What is Total Revenue (TR)?

Total revenue is the total money producers make from selling their products. It's figured out by this formula:

$\text{Total Revenue} = \text{Price} \times \text{Quantity Sold}$

Knowing how price changes affect total revenue is important for producers.

3. How Price Elasticity Affects Total Revenue

• When Demand is Elastic:

  • If the price goes down, total revenue goes up.

  • Example: If a popular snack bar drops in price from $2 to$1 and sales go from 1000 to 2000:

    • Before the price change: TR = $2 × 1000 =$2000

    • After the price change: TR = $1 × 2000 =$2000

  • Here, even if the price drops, total revenue can still stay the same or even increase when more is sold.

• When Demand is Inelastic:

  • If the price goes up, total revenue goes up too.

  • Example: If a luxury item price rises from $50 to$60 and sales drop from 100 to 80 units:

    • Before the price change: TR = $50 × 100 =$5000

    • After the price change: TR = $60 × 80 =$4800

  • In this case, even though fewer items are sold, the higher price means total revenue can still go up, just like in the previous example with elastic demand.

4. Key Takeaways

• For Elastic Demand:

  • If the price drops, total revenue goes up.
  • If the price goes up, total revenue goes down.

• For Inelastic Demand:

  • If the price drops, total revenue goes down.
  • If the price goes up, total revenue goes up.

5. Real-World Examples

We can see how elasticity works in everyday life. For instance, a report showed that in the consumer electronics world, some products have very elastic demand, while basics like bread often have inelastic demand.

A study found that if the price of some inelastic goods goes up by 1%, the number sold might drop by just 0.5%. However, total revenue might increase by 1.5%.

Producers need to understand how elastic their products are. This helps them set prices in a way that maximizes total revenue and influences how they run their business.