Question

Discuss an impact of price elasticity of demand on total revenue of the producer in case of an increase and a decrease of product price.

Give the example of producers that manipulate the price of their products to affect revenues on sales.

Answer 1

Price elasticity of demand has a very significant impact on the change in total revenue with respect to a change in the price. If the demand of a good is inelastic then an increase in the price would lead to an increase in the total revenues as the percent change in price is greater than the percent fall in demand. So if a good has inelastic demand it would be beneficial for the producer to increase the price. Similarly, a reduction in price would lead to a fall in total revenues.

When the demand of a good is elastic, a fall in price would lead to a rise in the total revenues as percent rise in demand is greater than percent fall in price. So if demand is elastic, it is beneficial for the producer to reduce the price. Similarly increasing price would lead to a fall in total revenues.

For example, oil is an inelastic good. So, the OPEC can artificially cut production to increase the oil price and hence their revenues.