Connection to Total Revenue

Remember, Total Revenue (TR) is a product of price (P) and quantity (Q). We write TR = P x Q . Thus as price goes up, Q declines (following the law of demand) and the impact of a price rise on Total Revenue seems uncertain. For example, consider the following price and quantity scenarios. The unit price of a pound of catfish and the relevant quantity demanded are shown in the table.

Price	Quantity	Total Revenue
$5	100	$500
$6	90	$540
$6	70	$420

As price goes up from $5 to $6, the quantity demanded falls to 90 units, and the seller's revenue rises to $540. If however, with the rise in price from $5 to $6, quantity demanded falls drastically to 70 units, then the seller's revenue falls to $420.

Thus raising prices is a risky proposition for businesses. The impact of the price rise on seller's revenue depends on how significantly the quantity demanded changes. Knowing this, a business owner may be in a dilemma whether to raise the price of his product or not. The knowledge of price elasticity of demand becomes significant in this situation. In many cases, businesses do controlled store tests before they decide on a price change.

If businesses know the price elasticity of demand for their product to be inelastic, then raising the price of their product will definitely lead to a rise in revenue for them. If on the other hand, businesses have calculated their price elasticity of demand to be elastic, then a rise in price is going to bring significantly less number of customers to the store and is going to reduce their revenue.

Sometimes businesses follow different pricing policy for different group of customers with different elasticities. Sometimes businesses may be able to identify price elasticity category of certain group of customers by certain actions they take. For example, airlines try to identify the vacationers from business travellers by requiring a Saturday night stay or a 14 -day advance purchase ticket. If the requirement of Saturday night stay or 14-day advance purchase is met (these conditions are likely to be met by a vacationer who has flexibility with time), then tickets from Dulles to San Francisco will be priced as $400. If these conditions are not met, the same economy plane ticket will cost $1200. By charging different consumers different prices based on their elasticity of demand for the product the businesses are likely to increase their revenue.

The same idea is applied when the department stores have special sales in the middle of the week and the sales flyer proclaims "50% off sale prices are effective only on Wednesday". The stores in these cases are trying to lure housewives and other people who are able to come to the store on a weekday. These people are likely to have very elastic demand for the products. By lowering the prices for these customers the department store is likely to have raised total revenue. On the weekend, the store may just run a sale with "30% off sale price" since the weekend shoppers are likely to be people with relatively inelastic demand.