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Total Revenue and Elasticity

A relationship between price elasticity and total revenue is shown in the figure above. Recall that total revenue is price x quantity. As price goes up, quantity demanded goes down. Thus, the effect on total revenue is unclear because if increase in price is more than off-set by decrease in quantity demanded, then total revenue will decrease.

If demand is relatively elastic then a decrease in price leads to a more than proportional increase in quantity demanded. This leads to an increase in total revenue. As can be seen in the graph below. On the other hand, when demand is relatively inelastic, a decrease in price leads to a less than proportional increase in quantity demanded. As a result, total revenue decreases.

In brief, total revenue is maximized when the elasticity of demand is unitary. In the graph above, that is at a price of 5. Consequently, if price falls or price rises from this price level, the total revenue will fall. To summarize, demand elasticity has a relationship with total revenue that depends on the size of the elasticity.

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