Total Revenue Method.pptx

Total revenue method

1. Total Revenue Method

2. 2 The Total Revenue Method The total revenue method is the simplest way of telling whether demand is elastic, inelastic.

3. 3 The Total Revenue Method The total revenue that would be received by sellers at various prices is found by multiplying price by quantity demanded.

4. 4 The Total Revenue Method When total revenue moves in the opposite direction to the price change, demand is elastic. Example: Price TR Price TR

5. 5 The Total Revenue Method At $1 consumers demand 100 units and the revenue equals $100. At 99c consumers demand 105 units and revenue equals $103.95. By price, Revenue . Demand is therefore elastic.

6. 6 The Total Revenue Method Total revenue remains the same when prices change if demand has unit elasticity. At $1 consumers demand 99 units and revenue equals $99. At 99c consumers demand 100 units and revenue equals $99

7. 7 The Total Revenue Method The price change has not resulted in any change in revenue. Demand is therefore unitary elastic.

8. Total Revenue Method Price Quantity Demanded (000s) D The importance of elasticity is the information it provides on the effect on total revenue of changes in price. $5 100 Total revenue is price x quantity sold. In this example, TR = $5 x 100,000 = $500,000. This value is represented by the grey shaded rectangle. Total Revenue

9. Elasticity Price Quantity Demanded (000s) D If the firm decides to decrease price to (say) $3, the degree of price elasticity of the demand curve would determine the extent of the increase in demand and the change therefore in total revenue. $5 100 $3 140 Total Revenue

10. inelasticity Price ($) Quantity Demanded 10 D 5 5 6 % Δ Price = -50% % Δ Quantity Demanded = +20% Ped = -0.4 (Inelastic) Total Revenue would fall Producer decides to lower price to attract sales Not a good move!

11. Elasticity Price ($) Quantity Demanded D 10 5 20 Producer decides to reduce price to increase sales 7 % Δ in Price = - 30% % Δ in Demand = + 300% Ped = - 10 (Elastic) Total Revenue rises Good Move!

12. Total Revenue Let's imagine we operate a small canteen in a school. I might say to you ''increasing the price of a can of Brand ''X'' soft drink from $1.00 per can to $1.40 per can is not a good idea. Our customers will buy Brand ''Y'' instead.'‘

13. ''At the moment, we are selling 200 cans per day of Brand ''X'', at $1.00 per can. We are generating $1.00 per can x 200 cans = $200 per day in revenue from sales of Brand ''X''. I believe that we will only sell 120 cans per day if we increase the price of Brand ''X'' to $1.40 per can; resulting in a daily revenue of ? $1.40 per can x 120 cans = $168.

14. Calculate the revenue gained The revenue we gain from increasing the price per can ($0.40 x 120 = $48) Calculate the revenue lost Will the revenue gained offset the revenue lost? It will not be enough to offset the revenue we will lose from the decrease in the quantity of cans we sell ($1.00 x 80 = $80).'' I show your reasoning, on a Supply and Demand diagram What is the reason for your conclusion? Why do you think this might be the case? Implicit in my reasoning is my belief that Brand ''X'' has a close substitute in Brand ''Y'', and that Brand ''X'' is price elastic.

15. You, however, are more in touch with teenage trends and fashion than I am. You reply ''Brand ''X'' is really popular at the moment. I believe we can increase the price to $1.40 per can. We will lose very few sales'‘. Using a Demand and Supply model show me your analysis of the market for brand ''X”, based on the belief that an increase in price to $1.40 per can will only cause a loss of 10 cans in sales per day.

16. The revenue gain from the increase in price ($0.40 x 190 cans = $76) will more than compensate for the revenue loss caused the decrease in quantity sold ($1.00 x 10 = $10) You have correctly noticed that Brand ''X'' is price inelastic, and that an increase in price will generate more net revenue.

17. Elasticity If demand is price elastic: Increasing price would reduce TR (%Δ Qd > % Δ P) Reducing price would increase TR (%Δ Qd > % Δ P) If demand is price inelastic: Increasing price would increase TR (%Δ Qd < % Δ P) Reducing price would reduce TR (%Δ Qd < % Δ P)

18. Mid point method There is a more accurate method to calculating elasticity This because a percent change in a given problem could be different depending on whether the price is increasing, or falling.  Check out the example below for a price change from $5 to $10: If the price increases to $10, then we have ($10-$5)/$5, which gives us $5/$5, or 100% However if the price decreases we have ($5-$10)/$10, which gives us -$5/$10, or -50%. depending on whether it is a price increase or decrease, then we will see different percentage values.  But if we use the midpoint formula, this won’t be a problem.  Let us look at our example above again.

19. Mid point method Formula is as follows – first step find average Where Xaverage is the sum of the old and new values divided by 2. i.e. if price increased from 10 dollars to 12 dollars, (12 + 10)/2 = 11 Ave P If quantity demanded fell from 30 to 20 items (20 + 30)/2 = 25 Ave Q midpoint elasticity = Ave P Δ Price X Δ Q Ave Q

20. The percentage change in price, calculated by the midpoint formula would be 2/11 = 18.2 percent The percentage change in quantity, calculated bye the midpoint formula would be 10/25 = -40 percent And the coefficient of elasticity, calculated by the midpoint formula is -40/18.2 = -2.2 The answer is negative because as the price goes up, we consume less of the good (which follows the law of demand).

21. Have a go at the following Price increase from $8 to $9 Quantity changes from 60,000 to 45,000 Calculate using mid point method

22. Calculate averages first i.e (45,000 + 60,000) /2 = midpoint elasticity = 8.5 1 X 15,000 52,500 = 2.43

23. Factors affecting Elasticity of Demand Time period – the longer the time under consideration the more elastic a good is likely to be. Short run demand relatively inelastic no time to adjust, long run demand relatively elastic E.g. installing LPG in car, trading car in on a hybrid Number and closeness of substitutes – the greater the number of substitutes the more elastic. Brands of petrol Price elasticity of a brand is greater than the price elasticity of a good

24. Factors affecting Elasticity of Demand The proportion of income taken up by the product – the smaller the proportion the more inelastic Expensive goods are likely to be relatively price elastic Why? Because they take up a larger proportion of income Luxury or Necessity – necessity goods such as food & drugs will be price inelastic Luxury items will be price elastic