We can think about how consumers respond to changes in price by considering the elasticity of the quantity demanded at a given price—how quickly does demand decrease as we raise prices? Price elasticity of demand is defined as % change in quantity% change in price; in other words, for price p and quantity q, this is pΔqqΔp (this looks kinda weird, and it wasn’t immediately obvious what’s happening here...). Revenue is the total amount of cash changing hands: pq.
What’s happening here is that raising prices is a good idea when the revenue gained (the “price effect”) outweighs the revenue lost to falling demand (the “quantity effect”). A lot of words so far for an easy concept:
If price elasticity is greater than 1, demand is inelastic and price hikes decrease revenue (and you should probably have a sale). However, if it’s less than 1, demand is elastic and boosting the price increases revenue—demand isn’t dropping off quickly enough to drag down the revenue. You can just look at the area of the revenue rectangle for each effect!
We can think about how consumers respond to changes in price by considering the elasticity of the quantity demanded at a given price—how quickly does demand decrease as we raise prices? Price elasticity of demand is defined as % change in quantity% change in price; in other words, for price p and quantity q, this is pΔqqΔp (this looks kinda weird, and it wasn’t immediately obvious what’s happening here...). Revenue is the total amount of cash changing hands: pq.
What’s happening here is that raising prices is a good idea when the revenue gained (the “price effect”) outweighs the revenue lost to falling demand (the “quantity effect”). A lot of words so far for an easy concept:
If price elasticity is greater than 1, demand is inelastic and price hikes decrease revenue (and you should probably have a sale). However, if it’s less than 1, demand is elastic and boosting the price increases revenue—demand isn’t dropping off quickly enough to drag down the revenue. You can just look at the area of the revenue rectangle for each effect!