TOTAL REVENUE TEST

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  Total Revenue

Total revenue (TR) is calculated by multiplying price (P) per unit and quantity (Q) of the good sold.

TR = P x Q

The total revenue test is a method of estimating the price elasticity of demand. As Ed will impact the total revenue, we can estimate the Ed by looking at the movement of the total revenue.

Total Revenue Test

Ed > 1, total revenue will decrease as price increases. P and TR moves in opposite directions. Producers can increase total revenue ( TR = Price x Quantity) by lowering the price. Therefore, most department stores will have sales to attract customers. Apparel's demand is elastic.

Ed < 1, total revenue will increase as price increases. P and TR moves in the same direction. Producers can increase total revenue by raising the price. Inelastic demand for agricultural products helps to explain why bumper crops depress the prices and total revenues for farmers.

You may look at the movement of TR in the example below. It demonstrated the relationship described above.

DEMAND FUNCTION FOR PRODUCT X: P = 2.5-0.01Q

P = PRICE; Q = QUANTITY, TR = TOTAL REVENUE

Ed = PRICE ELASTICITY OF DEMAND         

    A    B    C    D    E    F    G   H    I    J

Q: 0   50  100 150 200 250 300 350 400 450

P: 4.5  4   3.5  3   2.5   2   1.5   1   0.5   0

TR:0  200 350 450 500 500 450 350 200    0

ED: 17   5  2.6  1.57  1 0.64  0.38 0.2  0.06

ELASTICITY OF DEMAND;

FROM A TO E Ed >1     TR increases

FROM E TO F Ed =1      TR remains same.

FROM F TO J Ed <1       TR decreases.

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