Question

Suppose that you are a financial manager for a large electronic manufacturing in Malaysia. Define the concept of price elasticity of demand and explain what it tells us about total revenue (support with your own appropriate table and figures)

Answer 1

A General Definition:

Price Elasticity of Demand refers to the degree of responsiveness of the quantity demand for a good due to the change in its price.

In this context, the elasticity of demand tells us by how much the demand for electronic manufacturing changes if there is a change in the prices of electronic manufacturing items. Whether the demand increased by less than the fall in the price or vice - versa.

The concept of price elasticity of demand is important to understand the total revenue that the firm will be making in Malaysia.

There can be following three demand elasticities:

- Elastic Demand: % change in demand for electronic items > % change in price for electronic items. In the case, the elasticity is > 1

- Inelastic Demand: % change in demand for electronic items < % change in price for electronic items. In the case, the elasticity is < 1

- Unitary Elastic Demand: % change in demand for electronic items = % change in price for electronic items. In the case, the elasticity is = 1

Three Cases:

Case 1: When the demand is elastic:

Ed > 1. The price and Total Revenue generated will move in opposite directions. A fall in the price leads to rise in the total revenue and vice-versa.

Case 2: When the demand is inelastic:

Price and TR move in the same direction. A fall in the price leads to fall in the total revenue and vice-versa.

Case 3: When the demand is unit elastic:

Change in price will have no impact on the TR

Following table shows the impact of different elasticities on the TR:

Elasticity	Direction of Change in Price	Impact on TR
Elastic	Increase in Price	TR decreases
Inelastic	Increase in Price	TR increases
Elastic	Decrease in Price	TR increases
Unit Elastic	Increase in Price	TR constant