How does an increase in price affect total revenue?We are discussing determinants of elasticity in terms of a increase in price of a prouct.
We cannot know how an increase in price will affect total revenue unless we know the price elasticity of demand for the product. The more inelastic the demand, the more an increase in price will cause total revenue to increase. The more elastic the demand, the more a price increase will cause a decrease in revenue.
So, we have to know when demand for a product will be price elastic. Demand for a good or service is generally elastic if:
- There are substitutes for the product (or if the product is not a necessity). In these cases, if the price goes up, people simply buy something else.
- We are looking at demand in the long term. If the price of something goes up, in the long term, you can figure out ways to do without it even if you have to keep buying it in the short term.
- If the product costs a large amount relative to your budget. If something cheap doubles in price (let's say salt goes from $.50 to $1 per box), you'll still buy it because $.50 is not that much money. But if the price of something expensive doubles (say a car goes from $25,000 to $50,000) that is likely to be expensive relative to your budget and you will probably be much less likely to buy the car.