01:220:102 Lecture 7: 9/23 Lecture
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When a seller raises the price of an item one of the two will occur: A price effect: each unit sells at a higher price which tends to raise revenue. A quantity effect: fewer units are sold which tends to lower revenue. If demand for a good is unit-elastic (the price elasticity of demand is 1), an increase in price does not change total revenue. In this case, the quantity effect and the price effect exactly offset each other. If demand for a good is inelastic (the price elasticity of demand is less than 1), a higher price increases total revenue. In this case, the quantity effect is weaker than the price effect. If demand for a good is elastic (the price elasticity of demand is greater than 1), an increase in price reduces total revenue. In this case, the quantity effect is stronger than the price effect. Whether the good is a necessity or a luxury.