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A question in relation to Price Elasticity of Demand.

My understanding is that when demand is elastic, a price reduction will increase total revenue.

If the price of a product changes from \$100 to \$80 (20% decrease) and quantity demanded increases from 1000 to 1240 (24% increase), PED = 24/-20 = -1.2 (elastic).

Total revenue at the original price (\$100) and quantity demanded (1000) = \$100,000 Total Revenue after the price change is \$80 x 1240 = \$99,200 so total revenue has actually fallen

Can anyone reconcile this with the point that when demand is elastic a price reduction should increase total revenue?

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    $\begingroup$ If any answer does what you want, please consider ticking it as correct. A reputation of 1 is enough to do it. I remind you this because newcomers often forget to do so. See What should I do when someone answers my question? That being said, welcome on EC. $\endgroup$ – keepAlive Oct 25 at 10:56
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Like anything derived from calculus, the statement is guaranteed to hold true only for infinitesimal change. Unfortunately, since I don't know the entire demand function, I can't say much more than this.

A clear example of why this wouldn't work: starting at the same point \$100 and Q = 1000, we can decrease price to zero and total revenue would go down.

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    $\begingroup$ "we can decrease price to zero and total revenue would go down" regardless of the increase in quantity sold. $\endgroup$ – Giskard Oct 25 at 5:49
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My understanding is that when demand is elastic, a price reduction will increase total revenue.

Some readers may want to know that an elastic demand can either be unitary elastic ($E_d = −1$) or relatively elastic ($−∞ < E_d < −1$). When unitary elastic, the above statement is not true, strictly speaking.


Can anyone reconcile this with the point that when demand is elastic a price reduction should increase total revenue?

Actually, to be logically compatible with your "point" (in which the observed change in total revenue is the objective reference of accuracy), your elasticity should be smaller than $1$ (in absolute value). Which you do not get since you are using an approximation formulae, not good enough in this case. Indeed, as outlined in the other answer, this approximation formulae is only good for infinitesimal changes.

That being explained, note that the mathematical construct behind elasticities is based on continuous sets. A better approximation is then

$E_d = \frac{\ln(1240/1000)}{\ln(80/100)} = \frac{.215}{-.223} = -.964$

so $−1 < E_d < 0$, which caracterizes a relatively inelastic demand. In this case, as summarized on wikipedia, when the price goes down, the total revenu decreases... which is what you see. Put differently, the "reconciliation" you are searching lies in the fact that you are actually not dealing with an elastic demand.


NB: The better approximation here lies in computing variations as $\left[\ln\frac{a}{b}\right]$ instead of $\left[-1 + \frac{a}{b}\right]$. See this answer of mine for explanations.

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  • $\begingroup$ Any question @Gary ? $\endgroup$ – keepAlive Oct 25 at 10:57
  • $\begingroup$ The Wikipedia article you yourself link to says "The demand for a good is said to be elastic (or relatively elastic) when its PED is greater than one", which is the concept used by the OP. $\endgroup$ – Giskard Oct 25 at 20:14
  • $\begingroup$ @Giskard Sorry, I do not understand what you say. The PED of the OP is wrong. Correctly computed, it is lower than one (in absolute value), which reconciles this with the change in total revenue she sees. $\endgroup$ – keepAlive Oct 25 at 20:41
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    $\begingroup$ Seems I have misunderstood what you meant by "you do not precise how elastic your demand is". $\endgroup$ – Giskard Oct 25 at 21:30
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    $\begingroup$ I don't think "elastic" is generally used in this way (i.e. $\geq 1$ rather than $>1$), the Wikipedia page certainly doesn't use it like this. There it is clearly treated as a synonym. Anyway, this is but a nuance. $\endgroup$ – Giskard Oct 26 at 5:17

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