What this lesson teaches
I can use a diagram and a calculation to show how a price change affects consumer spending and firm revenue.
Syllabus K343, 2.6.4. PED, consumer expenditure and firms' revenue: effect of price changes on the amount spent by consumers and revenue raised by firms, shown both in a diagram and as a calculation; relationship between PED and the amount spent by consumers and revenue raised by firms
Make a guess
Demand for a bakery's loaves is price inelastic. The bakery raises its price by 10%. What happens to its total revenue?
- Revenue rises.
- Revenue stays the same.
- Revenue falls, because fewer loaves are sold.
Show the answer
Revenue rises.
Quantity falls by a smaller percentage than price rises, so price times quantity goes up.
If demand is elastic, a price cut raises revenue; if demand is inelastic, a price rise raises revenue.
Total revenue (TR) is price x quantity sold. It is the same as the total amount consumers spend on the good. PED tells a firm what happens to TR when it changes price.
If demand is elastic, a price cut raises TR. Quantity rises by a bigger percentage than price falls. A price rise reduces TR.
If demand is inelastic, a price rise raises TR. Quantity falls by a smaller percentage than price rises. A price cut reduces TR.
If demand is unitary, TR does not change when price changes. On a diagram, compare the revenue lost on existing units with the revenue gained on extra units.
- Total revenue
- Price x quantity sold; equals consumer expenditure.
- Elastic demand
- Price cut raises revenue; price rise lowers it.
- Inelastic demand
- Price rise raises revenue; price cut lowers it.
- Unitary
- Revenue unchanged when price changes.
Worked example: Calculating the change in revenue
Suppose a bakery raises the price of a loaf from $3.00 to $3.30. Daily sales fall from 400 to 380.
- Old revenue: $3.00 x 400 = $1,200.
- New revenue: $3.30 x 380 = $1,254. Revenue rises by $54.
- Check with PED: quantity falls 5% and price rises 10%, so PED = -0.5. Demand is inelastic.
- Conclusion: with inelastic demand, the price rise increased revenue, as predicted.
Try it step by step
Problem 1
A stall raises the price of a bowl of noodles from $4 to $5. Daily sales fall from 300 to 270 bowls.
Show the working
- Total revenue before: 300 x $4 = $1,200
- Total revenue after: 270 x $5 = $1,350
- Change in total revenue: $1,350 - $1,200 = +$150. Revenue rose, so demand is inelastic over this range.
Problem 2
A shop cuts the price of a phone charger from $10 to $8. Weekly sales rise from 100 to 150.
Show the working
- Total revenue before: 100 x $10 = $1,000
- Total revenue after: 150 x $8 = $1,200
- Change in total revenue: $1,200 - $1,000 = +$200. Revenue rose after a price cut, so demand is elastic.
Problem 3
A gym raises its monthly fee from $20 to $25. Members fall from 80 to 56.
Show the working
- Total revenue before: 80 x $20 = $1,600
- Total revenue after: 56 x $25 = $1,400
- Change in total revenue: $1,400 - $1,600 = -$200. Revenue fell after a price rise, so demand is elastic.
Watch out for this
A price cut always raises revenue because more is sold.
More is sold, but each unit earns less. Revenue rises only if demand is elastic. With inelastic demand, a price cut lowers revenue.
Check your understanding
Ticket sales at a cinema are unit elastic (PED = -1). If tickets become 10% cheaper, how do the cinema's takings change?
- They stay about the same
- They rise, as more tickets are sold
- They fall, as each ticket earns less
Show the answer
They stay about the same
Right. Quantity rises by the same percentage as the price falls, so price times quantity barely changes.
Check your understanding
Weekly sales are 1,000 units at $10 each, and PED is -2. If the firm lowers its price to $9, how much will it take in?
- $9,450 a week
- $9,000 a week
- $10,800 a week
- $12,000 per week
Show the answer
$10,800 a week
Right. A 10% price cut raises quantity 20%, to 1,200 units: 1,200 x $9 = $10,800.