Total Revenue and the Price Elasticity of Demand

When studying changes in supply or demand in a market one variable we often want to study is total revenue the amount paid by buyers and received by sellers of the good. In any market total revenue is P*Q the price of the good times the quantity of the good sold. We can show total revenue graphically.The height of the box under the demand curve is P, and the width is Q. The area of this box, P*Q equals the total revenue in this market .

How does total revenue change as one moves along the demand curve? The answer depends on the price elasticity of demand. If demand is inelastic as in then an increase in the price causes an increase in total revenue. Here an increase in price from $1 to $3 causes the quantity demanded to fall only from 100 to 80 total revenue rises from $ 100 to $240. An increase in price raises because the fall in is proportionately smaller than the rise P.

We obtain the opposite result if demand is elastic: An increase in the price causes a decrease in total revenue. When the price rises the quantity demanded falls from 50 to 20 and so total revenue falls from $200 to $100. Because demand is elastic the reduction in the quantity demanded is so great that it more than offsets the increase in the price. That is an increase in price reduces because the fall in Q is proportionately greater than rise in.

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