- A diversified company sells two products: generic salt, for which demand is highly inelastic, and a line of luxury smartwatches, for which demand is highly elastic. The company's board mandates a strategy to achieve a short-term increase in total revenue. Which pricing strategy is most likely to succeed?
Answer: Increase the price of salt while decreasing the price of smartwatches.
To increase total revenue, a firm should increase the price of goods with inelastic demand and decrease the price of goods with elastic demand. Increasing the price of salt (inelastic) will raise total revenue from salt. Decreasing the price of smartwatches (elastic) will raise total revenue from smartwatches. This strategy correctly applies the total revenue test to both products.
- A local bakery sells 200 loaves of sourdough bread daily at a price of $5.00 per loaf. The owner estimates the price elasticity of demand for the bread is 0.8. She is considering raising the price to $5.50 to increase revenue. What is the likely short-term impact of this price increase on total revenue?
Answer: Total revenue will increase because demand is price inelastic.
The price elasticity of demand is given as 0.8. Since this value is less than 1, demand is price inelastic. According to the total revenue test, when demand is inelastic, an increase in price will lead to an increase in total revenue. The decrease in quantity sold will be proportionally smaller than the increase in price.
- A monopolist sells a product for which demand is known to be price inelastic at the current price. The firm's primary goal is to maximize its profit. Assuming the cost of producing each unit is constant, which action should the firm take?
Answer: Increase the price, because this will increase total revenue and decrease total costs.
Since demand is inelastic, increasing the price will increase total revenue. Furthermore, increasing the price will cause the quantity sold to decrease. A decrease in the quantity produced and sold will lead to a decrease in total production costs. An increase in total revenue combined with a decrease in total costs guarantees an increase in profit (Profit = TR - TC).
- A company selling streaming subscriptions increases its monthly price from $10.00 to $10.50. Consequently, the number of subscribers falls from 2,100,000 to 2,000,000. Which of the following statements best describes the effect of the price change on the company's total revenue?
Answer: Total revenue remained unchanged because demand is unit elastic.
To determine the effect on total revenue, we must calculate it before and after the price change. Initial total revenue was $10.00 × 2,100,000 = $21,000,000. New total revenue is $10.50 × 2,000,000 = $21,000,000. Since the total revenue did not change, the demand for the subscription is unit elastic in this price range.
- An individual with a life-threatening condition requires a specific daily medication for which there are no substitutes. The pharmaceutical company that produces the medication doubles its price. Assuming the individual must obtain the medication, what is the effect on the company's total revenue from this patient's purchases?
Answer: Total revenue will approximately double.
This scenario describes perfectly inelastic demand: the quantity demanded does not change regardless of the price. If price (P) doubles and quantity (Q) remains constant, then total revenue (P × Q) will also double. The patient's expenditure doubles, which means the company's revenue from that patient doubles.
- If a 4% increase in the price of a product causes the total revenue from that product to decrease by 2%, what can be inferred about the product's price elasticity of demand?
Answer: Demand is elastic.
The total revenue test states that if price and total revenue move in opposite directions, demand is elastic. In this case, price increased (+4%), but total revenue decreased (-2%). This inverse relationship confirms that demand is price elastic in this range.
- A regional farming cooperative experiences an unexpectedly large harvest of corn, a product with a known price-inelastic demand. The cooperative must sell the entire harvest on the open market. What is the most likely impact of the bumper crop on the cooperative's total revenue compared to a normal year?
Answer: Total revenue will decrease because the large increase in quantity will cause a proportionally larger decrease in price.
For a good with inelastic demand, consumers are not very responsive to price changes. A large increase in quantity supplied to the market will lead to a sharp drop in the equilibrium price. Because demand is inelastic, the percentage decrease in price will be greater than the percentage increase in quantity sold, causing total revenue (P × Q) to fall.
- A specialty coffee shop increases the price of its signature latte by 10%. Following this change, the shop's total revenue from lattes increases by 5%. Based on this information, which of the following must be true regarding the demand for the signature latte in this price range?
Answer: It is price inelastic, as the percentage decrease in quantity demanded was less than 10%.
When price and total revenue move in the same direction (both increased), demand is price inelastic. For total revenue to increase by 5% when price increased by 10%, the quantity demanded must have decreased by approximately 5%. Since the percentage decrease in quantity demanded is less than the percentage increase in price, demand is, by definition, inelastic.
- A company has determined that its product is currently priced at the point of unit elasticity on its demand curve, where its total revenue is maximized. The government then imposes a per-unit tax on the product, which the company passes on to consumers by raising the price. What will be the immediate effect of this price increase on the company's total revenue?
Answer: Total revenue will decrease.
The point of unit elasticity is where total revenue is at its maximum. Any movement away from this point, either by increasing or decreasing the price, will cause total revenue to fall. By raising the price, the company moves from the unit-elastic point into the elastic portion of the demand curve. In the elastic region, a price increase always leads to a decrease in total revenue.
- A company is considering a price change for its product. Under which of the following conditions is a price increase guaranteed to result in an increase in the company's total revenue?
Answer: The percentage decrease in quantity demanded is smaller than the percentage increase in price.
This statement is the mathematical definition of price inelastic demand. If the quantity demanded is not very responsive to the price change (i.e., its percentage decrease is smaller than the percentage price increase), then the price effect will dominate the quantity effect, and total revenue (P × Q) will rise. This is the underlying logic of the total revenue test.
- A firm faces a downward-sloping demand curve. It raises its product's price by 5%, which causes its total revenue to increase by exactly 5%. What can be concluded about the price elasticity of demand for its product in this range?
Answer: Demand is perfectly inelastic.
Total revenue (TR) is Price (P) times Quantity (Q). The new total revenue is TRnew=Pnew×Qnew. We are given that TRnew=1.05×TRold and Pnew=1.05×Pold. Substituting these into the equation gives 1.05×TRold=(1.05×Pold)×Qnew. Dividing both sides by 1.05 gives TRold=Pold×Qnew. Since TRold=Pold×Qold, it must be that Qnew=Qold. If quantity demanded does not change when price changes, demand is perfectly inelastic. - A video game publisher observes that demand for a new game is highly elastic upon release but becomes progressively more inelastic as a dedicated player base forms. To maximize total revenue over the game's first year, the publisher should consider which of the following pricing strategies?
Answer: Start with a lower price and gradually increase it over time.
The total revenue test dictates that to maximize revenue, the price should be low when demand is elastic and high when demand is inelastic. Therefore, starting with a lower price caters to the initial elastic demand to boost revenue. As demand becomes more inelastic over time, the price can be raised to further increase total revenue.
- Which of the following scenarios demonstrates a correct application of the relationship between price elasticity and total revenue?
Answer: A farmer with an inelastic product expects lower total revenue from a bumper crop.
For a product with inelastic demand, such as many agricultural goods, a large increase in supply (a bumper crop) floods the market, causing a proportionally much larger drop in price. This leads to a decrease in total revenue for the sellers. This is a classic application of the concept.
- A software company sells a popular video game and assumes the game has a standard, downward-sloping linear demand curve. The company decides to progressively lower the price of the game over several months. Which of the following describes the most likely path of the company's total revenue as it lowers the price?
Answer: Total revenue will first increase, reach a maximum, and then decrease.
A linear demand curve is elastic in its upper portion (at high prices) and inelastic in its lower portion (at low prices). As the price is lowered from a high level, the firm moves through the elastic range, where price cuts increase total revenue. Total revenue is maximized at the point of unit elasticity. As the price is lowered further into the inelastic range, price cuts cause total revenue to decrease.
- The manager of a local cinema observes that after reducing the price of a matinee ticket by 15%, total revenue from those ticket sales declined. This outcome suggests that for the observed price range, the demand for matinee tickets is:
Answer: price inelastic.
The total revenue test states that if price and total revenue move in the same direction, demand is inelastic. In this scenario, the price was reduced (decreased) and total revenue also declined (decreased). Therefore, demand for the tickets in this price range must be price inelastic.
- A market research consultant informs a startup that pre-launch surveys indicate the demand for their new smart home device is highly price elastic. To generate the highest possible initial total revenue, which pricing strategy should the startup implement?
Answer: Set a relatively low introductory price to capture a large market share.
When demand is price elastic, total revenue and price move in opposite directions. To increase total revenue, the firm must lower the price. A lower price will cause the quantity demanded to increase by a proportionally larger amount, thus raising total revenue. Setting a low introductory price is the correct strategy.
- A municipal government needs to increase tax revenue and plans to introduce a new per-unit excise tax on a consumer good. To maximize the revenue generated by this tax while minimizing the reduction in the quantity of the good sold, the government should tax a good for which consumer demand is:
Answer: highly price inelastic.
When demand is price inelastic, consumers are not very responsive to price changes. A tax increases the effective price for consumers, but the quantity demanded will fall by a smaller percentage. This ensures the tax base (the quantity sold) does not shrink significantly, leading to higher and more stable tax revenue for the government.
- The manager of a concert venue notices that despite adjusting ticket prices up and down slightly for different shows over the past year, the total revenue generated per show has remained remarkably stable. What does this observation most strongly imply about the demand for tickets in the price range of the adjustments?
Answer: The venue is likely pricing its tickets in the unit-elastic range of the demand curve.
If changes in price do not affect total revenue, it means the percentage change in price is being exactly offset by an equal and opposite percentage change in quantity demanded. This is the definition of unit elastic demand. In this range, raising or lowering the price does not change total revenue.
- Government data reveals that after a 5% average increase in the price of gasoline nationwide, total consumer expenditure on gasoline rose by 3%. This data suggests that, within this price range, the demand for gasoline is:
Answer: price inelastic.
Total consumer expenditure on a product is equivalent to the total revenue received by its sellers. The total revenue test indicates that if price and total expenditure/revenue move in the same direction, demand is inelastic. Here, price increased by 5% and total expenditure also increased (by 3%), so they moved in the same direction, signifying inelastic demand.
- A local cafe decides to increase the price of its standard house coffee by 10%. After one week, the manager observes that fewer cups of coffee were sold. What can be concluded about the cafe's total revenue from house coffee?
Answer: The change in total revenue cannot be determined without knowing the magnitude of the decrease in quantity sold.
Total revenue equals price times quantity (TR = P × Q). We know price increased and quantity decreased. The net effect on total revenue depends on the price elasticity of demand. If demand is inelastic, the percentage decrease in quantity will be less than 10%, and total revenue will rise. If demand is elastic, the percentage decrease in quantity will be more than 10%, and total revenue will fall. Without knowing the elasticity or the exact quantity change, the effect on total revenue is unknown.
