Understanding the Relationship Between Total Revenue and Elasticity
Review: Total revenue is price times quantity demanded: TR = P x Q.
Review: Elastic demand indicates price sensitivity; inelastic demand indicates price
insensitivity.
When price changes, you can analyze the change in total revenue in terms of a price
effect and a quantity effect. Elasticity determines which effect is greater after a change
in price.
Begin this section by reviewing the formula for
total revenue: TR = P x Q.
The box on the left summarizes the
relationship between price changes, total
revenue, and elasticity:
1. With products that are price-sensitive, or
elastic, a percentage change in price means a
greater percentage change in quantity
demanded. Total revenue and price move
in opposite directions.
2. With products that are price-insensitive, or
inelastic, a percentage change in price
means a smaller percentage change in
quantity demanded. Total revenue and
price move in the same direction.
Using math shows that the relationships on
the left are true.
The mathematical relationship above is
analogous to the formula for finding a change
in total revenue when the price changes.
The formula in the lower part of the box on
the left says that the percentage change in
total revenue is equal to the percentage
change in price + the percentage change
in quantity demanded.
