Principles of Economics- Mankiw (5th) 96

Principles of Economics- Mankiw (5th) 96 - When a demand...

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100 PART TWO SUPPLY AND DEMAND I: HOW MARKETS WORK to 80, and so total revenue rises from $100 to $240. An increase in price raises P ± Q because the fall in Q is proportionately smaller than the rise in P. We obtain the opposite result if demand is elastic: An increase in the price causes a decrease in total revenue. In Figure 5-4, for instance, when the price rises from $4 to $5, the quantity demanded falls from 50 to 20, and so total revenue falls from $200 to $100. Because demand is elastic, the reduction in the quantity de- manded is so great that it more than offsets the increase in the price. That is, an in- crease in price reduces P ± Q because the fall in Q is proportionately greater than the rise in P. Although the examples in these two figures are extreme, they illustrate a gen- eral rule: ± When a demand curve is inelastic (a price elasticity less than 1), a price increase raises total revenue, and a price decrease reduces total revenue.
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Unformatted text preview: When a demand curve is elastic (a price elasticity greater than 1), a price increase reduces total revenue, and a price decrease raises total revenue. In the special case of unit elastic demand (a price elasticity exactly equal to 1), a change in the price does not affect total revenue. Demand Quantity Price Revenue $200 $4 50 Demand Quantity Price Revenue $100 $5 20 Figure 5-4 H OW T OTAL R EVENUE C HANGES W HEN P RICE C HANGES : E LASTIC D EMAND . With an elastic demand curve, an increase in the price leads to a decrease in quantity demanded that is proportionately larger. Therefore, total revenue (the product of price and quantity) decreases. Here, an increase in the price from $4 to $5 causes the quantity demanded to fall from 50 to 20, so total revenue falls from $200 to $100....
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