Total revenue is price × quantity sold. When price changes, elasticity tells you whether quantity falls by a larger or smaller percentage, and that decides whether revenue rises or falls.
This lesson uses the values you learned to read in interpreting an elasticity value and sign. It belongs to the wider topic elasticity.
What is the rule, and when does it hold?
The rule for a price rise:
- Inelastic demand (size below 1): quantity falls by a smaller percentage, so revenue rises.
- Unitary demand (size equal to 1): the two effects roughly cancel, so revenue stays about the same.
- Elastic demand (size above 1): quantity falls by a larger percentage, so revenue falls.
For a price fall, the results reverse. Elastic demand means revenue rises, and inelastic demand means revenue falls.
The rule holds under stated assumptions: other influences on demand stay constant, the elasticity value stays the same across the price range, and the price change is small. For larger changes, the unitary case is only approximate, as the example shows.
Worked example
Warung Tiga is a fictional food stall. It sells 500 plates a week at RM10, so revenue is RM5,000. It plans a 10% price rise to RM11.
Case A, inelastic (PED = −0.5): quantity falls 5%, so 500 × 0.95 = 475 plates. Revenue = 11 × 475 = RM5,225. Revenue rises by RM225.
Case B, elastic (PED = −2): quantity falls 20%, so 500 × 0.80 = 400 plates. Revenue = 11 × 400 = RM4,400. Revenue falls by RM600.
Case C, unitary (PED = −1): quantity falls 10%, so 450 plates. Revenue = 11 × 450 = RM4,950. It is close to RM5,000 but not exact, because a 10% rise followed by a 10% fall in quantity gives 1.10 × 0.90 = 0.99 of the original.
The mistake to watch for
A frequent slip is to treat elasticity as the cause of the revenue change, or to forget the direction of the price move.
Mistaken answer: “PED is −2, so demand is elastic, so revenue rises when the stall raises the price.”
The student remembered “elastic means revenue moves a lot” and ignored the direction.
The correction is to compare the two percentages. A price rise of 10% with a quantity fall of 20% gives revenue 1.10 × 0.80 = 0.88 of the original, a fall of 12%. Always state the price direction and the assumptions.
Check yourself
1. A fictional shop sells 300 items at RM20, so revenue is RM6,000. Price falls 10% and PED is −1.5. Find the new revenue.
Show answer
New price = RM18. Quantity rises 15%: 300 × 1.15 = 345. Revenue = 18 × 345 = RM6,210, a rise. Demand is elastic, so a price fall raises revenue.
2. The same shop raises price 5% and PED is −0.4. Find the new revenue.
Show answer
New price = RM21. Quantity falls 2%: 300 × 0.98 = 294. Revenue = 21 × 294 = RM6,174, a rise. Demand is inelastic.
3. The shop raises price 20% and PED is −1.2. State the direction of revenue and give the new figure.
Show answer
New price = RM24. Quantity falls 24%: 300 × 0.76 = 228. Revenue = 24 × 228 = RM5,472, a fall. Demand is elastic.
Where this leads next
Elasticity changes with time, which is the focus of why a short-run response may differ. The elasticity tutor lets you test price changes, and the percentage-base explorer checks your percentages.
Students can know the rule and still lose the mark on the assumptions. Our teachers practise that wording in online one-to-one Economics tuition.