Question

Then, Smith made a phone call to ask Diana if increasing the market price of orange would boost his sales revenue this year. She responded by saying, "Hmmm, that is a good question, but it is hard to say with 100% certainty because it depends on the consumer's responses to a change in the price of an orange".

Diana advised Smith by saying, "it is hard to say with 100% certainty because it depends on consumer's responses to a change in the price of an orange". Discuss what that means, using the relationship between the change in total revenue and the change in the price. Please refer to pp. 163-164.

Answer 1

The change in revenue because of a change in price depends on the price elasticity of demand. The following are the three possible cases:

1) Elastic Demand: In case of elastic demand, the % change in quantity is higher than the % change in price. Therefore, in case of elastic demand increasing price results in lower revenue and decreasing price results in higher revenue.

2) Inelastic Demand: In case of inelastic demand, the % change in quantity is lower than the % change in price. Therefore, in case of inelastic demand increasing price results in higher revenue and decreasing price results in lower 'revenue.

3) Unitary Elastic Demand: In case of unitary elastic demand, the % change in quantity is equal to the % change in price. Therefore, in case of unitary elastic demand, increasing or decreasing price does not affect revenue.