Price Elasticity and Change in Total Revenue with Respect to Price 1.

By definition, total revenue (TR) is obtained by multiplying quantity demanded of a product (Qx) by price (Px), that is, TR = Qx Px. (1)

In class, by taking the derivative of the above total revenue equation with respect to price (dTR/dPx), we obtain the following general functional relation:
TR/ Px = Qx (1 + Ep)

(2).

In Equation (2), Ep represents the price elasticity of demand. Since Ep is always negative, Equation (2) can be modified as follows:
TR/ Px = Qx (1 - |Ep| )

(3).

Based on Equation (3) we can deduce the following general relationships between a change in total revenue and price, and price elasticity of demand. a) If |Ep| > 1, then TR/ Px < 0. In plain English, this says that when demand is price elastic, the relationship between price and total revenue is negative. That is, an increase in price will decrease total revenue and a decrease in price will have the opposite effect on total revenue. b) If |Ep| < 1, then TR/ Px > 0. Again, in plain English, this says that when demand is price inelastic, the relationship between price and total revenue is positive. That is, an increase in price will have the effect of increasing total revenue and a decrease in price will cause a decline in revenue. c) If |Ep| = 1.0, then TR/ Px = 0. Thus, a change in price will have no effect on total revenue. Marginal Revenue and Elasticity TR = Qx Px. In class, by taking the derivative of the above total revenue equation with respect to quantity ( TR/ Qx), we obtain the following general functional relation: MR= TR/ Qx = Px (1 + 1/Ep) (4).

In Equation (4), Ep represents the price elasticity of demand. Since Ep is always negative, Equation (4) can be modified as follows: MR= TR/ Qx =Px (1 1 ) Ep

(5)

Based on Equation (5) we can deduce the following general relationships between a marginal revenue and price elasticity of demand. a) If |Ep| > 1, then TR/ Qx > 0. So, MR > 0. In plain English, this says that when demand is price elastic, MR is positive. That is, an increase in quantity will increase total revenue and a decrease in quantity will decrease total revenue. b) If |Ep| < 1, then TR/ Qx < 0. Again, in plain English, this says that when demand is price inelastic, the relationship between price and total revenue is negative. That is, an increase in quantity will have the effect of decreasing total revenue and a decrease in quantity will cause a rise in revenue. d) If |Ep| = 1.0, then TR/ Qx = 0. Thus, a change in quantity will have no effect on total revenue.

Relationships of Total Revenue and Price Elasticity and Marginal Revenue.

P Q P.Q 95 180 320 420 480 480 420 320 180 17 14 10 3.33 0 -6 -10 -14 -19 -9 -4 -2.1 -1.25 -0.67 -0.43 -0.25 MR Elasticity

19 18 16 14 10 8 6 4 2

5 10 20 30 48 60 70 80 90

The following three observations can be made from the above table:

In the region of the demand schedule where the absolute value of price elasticity is less one (inelastic), MR is negative In the region of the demand schedule where the absolute value of price elasticity is unitary, MR is zero and total revenue is at its maximum. In the region of the demand schedule where the absolute value of price elasticity is greater than 1, MR is positive