Question

Explain the relationship between price elasticity of demand and total revenues

Short answer

The relationship between price elasticity of demand and total revenues is explained

Step-by-step solution

Introduction 

The ratio of the percentage change in quantity demanded of a product to the percentage change in price is known as price elasticity of demand.

Total revenue is the total amount of all goods and services sold.

Relationship between price elasticity of demand and total revenue

When the price rises, the quantity decreases. The original price and quantity, as well as the slope of the demand curve, determine whether overall revenue will increase or decrease.

If the percentage increase in quantity is greater than the % decrease in price, overall revenue will grow as a result of the increase in quantity.

A product's elastic or inelastic demand is determined by the percentage change in price and quantity.

General rules for the relationship of price elasticity of demand and total revenue

1. When demand is inelastic (price elasticity $1$), price and total revenue have a positive relationship, which means that as price rises, total revenue rises as well.

2. When demand is elastic (price elasticity $>1$), price and total revenue have a negative relationship, meaning that price rises lead to lower total revenue.

3. When demand is unit elastic (price elasticity $=1$), price changes have no effect on total revenue. When the demand elasticity is $1$, the total revenue is maximized.