Theory question 103
ElasticityWith an appropriate illustration, explain the circumstance in which an increase in output of a producer would (a) decrease his sales revenue; (b) increase his sales revenue.
Show the model answer
(a) When demand for the product is inelastic (coefficient < 1): to sell more the producer must cut price, and the percentage fall in price is greater than the percentage rise in quantity sold, so total revenue falls (e.g. farm produce in a bumper harvest). Illustrate with a steep demand curve or a numerical example (e.g. price falls from N10 to N5, quantity rises from 10 to 12: TR falls from N100 to N60).
(b) When demand is elastic (coefficient > 1): a small fall in price brings a more than proportionate rise in quantity sold, so total revenue rises. Illustrate with a flat demand curve or numbers (e.g. price falls from N10 to N8, quantity rises from 10 to 20: TR rises from N100 to N160).
(Also: if price stays constant, as for a perfect competitor, more output always raises revenue.)
Link the effect on total revenue to the elasticity of demand.