What is the explanation of the reltionship between the price elasticity of demand and the total revenue
The price elasticity of demand measures the responsiveness of the quantity demanded of a good or service to a change in its price. It tells us how much the demand for a product changes when its price changes. The relationship between the price elasticity of demand and total revenue can be explained as follows:
1. Price Elastic Demand (PED > 1): When demand is price elastic, a decrease in price will lead to a proportionately larger increase in quantity demanded, and vice versa. In this case, the percentage change in quantity demanded is greater than the percentage change in price. As a result, when the price decreases, the total revenue increases, and when the price increases, the total revenue decreases.
2. Price Inelastic Demand (PED < 1): When demand is price inelastic, a change in price will result in a proportionately smaller change in quantity demanded. Here, the percentage change in quantity demanded is less than the percentage change in price. Consequently, when the price decreases, the total revenue decreases, and when the price increases, the total revenue increases.
3. Unitary Price Elastic Demand (PED = 1): When demand is unitary price elastic, the percentage change in quantity demanded is equal to the percentage change in price. In this case, any price change doesn't impact total revenue significantly. When the price decreases or increases, the total revenue remains unchanged.
To calculate the price elasticity of demand, you need two pieces of information: the percentage change in quantity demanded and the percentage change in price. The formula for PED is:
PED = (Percentage change in quantity demanded) / (Percentage change in price)
To determine the impact of price elasticity on total revenue, you can use the formula:
Total Revenue = Price * Quantity Demanded
Understanding the concept of price elasticity of demand and total revenue provides insights into how changes in price can affect a business's revenue and profitability.