PRICE AND REVENUE

QUESTION: CAN A BUSINESS ALWAYS INCREASE REVENUES BY INCREASING PRICES?

MOST PEOPLE WOULD SAY “YES”

BUT, REMEMBER THE “DEMAND CURVE”

BUYERS WILL RESPOND – BUY LESS WHEN PRICE UP; BUY MORE WHEN PRICE DOWN

REVENUE = PRICE x QUANTITY BOUGHT

PRICE UP, QUANTITY DOWN, UNCLEAR WHAT HAPPENS TO REVENUE

“PRICE INELASTIC” DEMAND CURVE BUYERS REDUCE AMOUNT BOUGHT (QUANTITY) VERY LITTLE WHEN PRICE RISES

REVENUE RISES

EXAMPLES: GASOLINE, FOOD, ELECTRICITY, OTHER FUELS

“PRICE ELASTIC” DEMAND CURVE

BUYERS REDUCE AMOUNT BOUGHT (QUANTITY) SUBSTANTIALLY WHEN PRICE RISES

REVENUE FALLS

AIRPLANE TRIPS, LUXURY VEHICLES, FOREIGN TRAVEL, MASS TRANSIT

NUMERICAL EXAMPLE – PRICE INELASTIC DEMAND CURVE

PRICE PER GALLON GALLONS BOUGHT REVENUE

$2 30 $60

$4 20 $80

NUMERICAL EXAMPLE – PRICE ELASTIC DEMAND CURVE

PRICE PER BUS RIDE # RIDES PER MONTH REVENUE

$1 10,000 $10,000

$2 3,000 $6,000

NUMBERS CAN BE DERIVED FOR PRICE ELASTICITY OF DEMAND

FORMULA: % CHG IN QUANTITY BOUGHT % CHG IN PRICE

ALWAYS NEGATIVE

NEGATIVE “BIGGER” THAN -1: ELASTIC (-1.5, -4)“FRACTIONAL” NEGATIVE”: INELASTIC (-0.33, -0.78)

EXAMPLE 1

• Gas example price changes from $2 to $4 per gallon and quantity bought declines from 30 gallons to 20 gallons

elasticity = -33%/100% = -0.33

PRICE ELASTICITIES OF DEMAND CAN CHANGE

BECOME MORE ELASTIC OVER TIME AS BUYERS ADJUST

CAN BECOME MORE ELASTIC AS NEW COMPETITIVE PRODUCTS ARE INTRODUCED (CABLE TV, SATELITTE TV)