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The Relationship Between Price Elasticity and Sales Revenue

Lets start with some basics.

Total Revenue = Price of individual goods or service x quantity of product sold

If Unit Elasticity was in effect, ie the Elasticity of Demand was equal to 1, then a 1% rise in price would result in a 1% drop in demand (and vice versa) assuming that the correlation was a negative one

i.e Ed = (-)1.

But this is unlikely to be found in the real world, in particular for anything more than a small stretch of the demand curve.

When the elasticity of demand is seen to be inelastic (ie Ed < 1 ) is can be seen:

  1. an increase in Po causes a reduction in Q but an increase in revenue.
  2. a decrease in Po causes as increase in Q but a decline in revenue.

When the elasticity of demand is said to be elastic (Ed > 1 ) it can be seen:

  1. an increase in Po causes a reduction in Q but a decrease in revenue.
  2. a decrease in Po causes causes an increase in Q but an increase in revenue.

Marginal Revenue

Marginal Revenue is the change in total revenue seen as the firm sells one more unit of its product.

MR = change in TR / change in Q

demand curve maximum revenue curve

Average Revenue

This is the total revenue divided by the output, or simply put the average revenue achieved per product sold.

AR = TR/Q

It is obvious to see that when the price per unit is equal the average revenue is the revenue achieved for per product sold and therefore the demand curve is also the average revenue curve.

There are some key relationships to notice from the graphs above:

  • Marginal Revenue falls as output rises. Since the demand curve slopes downward the additional revenue per extra unit decreases. This demonstrates the Law of Diminishing Marginal Returns.
  • Average Revenue exceeds Marginal Revenue when the slope of the demand curve is negative.
  • Marginal Revenue curve declines at twice the rate than the Demand Curve (also the revenue curve as stated above). Note the MR curve cuts midway between OC.
  • Total Revenue increases whilst MR is positive. This is due to the elastic nature of demand from AB on DD.
  • Total Revenue falls whilst MR is negative. This is due to the inelastic nature of demand from BD on DD.
  • Total revenue is maximised when MR is ‘0’, which is seen when unit elasticity is reached.

Please note that during these discussions and examples all other factors are ceteris paribus.

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About loganjehall

I focus on building an internal culture focussed on listening to and working alongside customers to build value for all stakeholders. Real lasting change that understands the real needs of the customer is the only way to ensure a dynamic constant state of learning and innovation. I am a highly experienced sales, marketing and business professional with wide ranging experience in varied industries. Having worked in both B2B and B2C I understand sales and business is really about P2P (people to people) and therefore always focus on relationships and engagement. "Business is socialising with a purpose" (Gaping Void) Passion, people, vision, strategy, customers, advocates, believers, innovation, customer engagement, social, knowledge management and appropriate use of technology are vital in the attainment of business goals. I am a co-founder of Movebubble, a new technology startup in #Proptech. This blog is really here to allow me to develop my voice and ideas, and gain feedback from a wider audience than just the lecture or breakout room. Hopefully i can introduce some interesting points, and experiment with digital, marketing, engagement, social media and SEO techniques and tips i am learning on the way. I hope you enjoy my posts, please let me know what you think with some feedback.

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