PED & Total Revenue
- Revenue is the amount of money a firm receives from selling its goods/services
- Total revenue = price x quantity
- The total revenue rule states that in order to maximise revenue, firms should increase the price of products that are inelastic in demand & decrease prices on products that are elastic in demand
- This can be illustrated using a demand curve
An illustration of price elastic demand where a small decrease in price from P1→P2 causes a large increase in quantity demanded from Q1→ Q2
Diagram Analysis
- The demand curve is very elastic in this market
- When a good/service is price elastic in demand, there is a greater than proportional increase in the quantity demanded to a decrease in price
- Total revenue is higher once the price has been decreased
An illustration of price inelastic demand where a large increase in price from P1→P2 causes a small decrease in quantity demanded from Q1→ Q2
Diagram Analysis
- The demand curve is very inelastic in this market
- When a good/service is price inelastic in demand, there is a smaller than proportional decrease in the quantity demanded to an increase in price
- Total revenue is higher once the price has been increased
Worked example
A firm raises the price of its products from £10 to £15. Its sales have fallen from 100 to 40 units per day. Explain if they made the correct decision
Step 1: Calculate the initial sales revenue
Step 2: Calculate the sales revenue after the price change
Step 3: Explain the decision
By raising the price, the total revenue has fallen by £400. This indicates that the product is price elastic in demand and the firm should have lowered their price in order to maximise revenue
Exam Tip
A common error students make is to say that when prices increase and the product is inelastic in demand, the quantity demanded does not fall. It does! But it is a less than proportional fall than the increase in price.
So, when Governments tax demerit goods such as cigarettes, the increase in price is greater than the decrease in QD, but QD still falls.