Lecture 7-Price Elasticity of Demand and Total Revenue

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1 Aug 2010
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Tuesday, October 6th, 2009.
Price Elasticity of Demand and Total Revenue
Total Revenue = Price x Quantity
In response to an increase in price, total revenue:
- increases if demand is inelastic
- is unchanged if demand is unit elastic
- decrease if demand is elastic
Inelastic Demand Curve (TR 9 if P 9)
TR0 = P0 x Q0 (Revenue at old price)
TR1 = P1 x Q1 (Revenue at higher price)
Revenue increase: (P1 ± P0) x Q1
Revenue decreases: P0 x (Q0 ± Q1)
Toronto Transit Commission
Price (fare) 9 Æ TR 9, because
DD is inelastic (few close substitutes)
One of Five Toll Bridges Across River
Price (toll) 9 Æ 75; because
DD is elastic (several close substitutes)
Q1
Q0
P0
P1
Q
P
xxx
xxx
xx
xx
xx
xx
Revenue Increase
Revenue Decrease
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Income Elasticity of Demand:
Percent change in quantity demanded
Percent change in income
Normal good: income elasticity > 0
Inferior good: income elasticity < 0
Insight: Most goods are normal goods
Few goods are inferior goods
(Example: bus travel)
Income Increases
Normal good: DD shifts to right
DQ³LQFUHDVHLQGHPDQG´
Inferior Good: DD shifts to left
D³GHFUHDVHLQGHPDQG´
Q1
SS
P
Q
P
DD1 (income increases)
DD
Q
P1
Q1
SS
P1
Q
P
DD1 (income increases)
DD
Q
P
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