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“Right welcome back welcome back price and quantity effect all right. So why do elasticity elasticity tennessee. Matter. So why are we even bothering to learn this in the first well one of the big reasons is because producers might actually be able to increase their revenue by changing that price so higher price or low price could actually increase their total revenue depending on whether demand is elastic or inelastic.
So that can be what this video is really going to get into all right. So. Let s premature. I just said depending on whether demand is unit.
Elastic. Inelastic or elastic predicts. How changes in the price of a good will affect total revenue prior to buy producers. All that good so if the price were to go from p2 to p1 so an increase in the price.
We know that orange law of demand. We re going to decrease our quantity demanded so we re going to go from q2 to q1. But depending on whether demand is elastic inelastic or unit will affect what exactly happens the total revenue in that situation. So we ll define total revenue total revenue is equal to p times.
Q. Let s price times. Quantity so in this case. You see the model here for you price is five dollars ten units are sold so total revenue is five dollars as our price.
Very simple we do five times 10 equals 50. Dollars. So that would be the total revenue price times. Quantity so again everything we re doing in this video is kind of trying to see well what happens to our total revenue.
If the price were to go up to six dollars or let s say the price were to fall to four dollars. How much of a change are we going to have and the quantity demanded is it actually enough to possibly even increase total revenue. All right so we have two things that are happening here simultaneously. We have a price effect and we have a quantity effect and we ll do the quantity effect in the next video or sorry.
The next slide. So the price effect. If you look at our model..
Here and assume that we have moved from point b to point a now again that s the price has gone up from p2 to p1 and our quantity is decreased from q 2 2 q. 1 with price effect. We only care about what happened to the price. So.
The idea here is because the price went up from p2 to p1 each unit. That is sold is now selling at a higher price. So the price effect suggests that a higher price should increase revenue. All right price effect suggests that a higher price should increase revenue and conversely.
It suggests that a lower price should decrease revenue. That s the price affect the quantity effect on the other hand focuses on what happens to the quantity. Demanded this one is going to suggest the opposite because when we move from point b to point a. We now demand fewer smaller quantities so we go from q2 to q1 so our quantity has decreased.
So that big pink box there pink rectangle those are all the goods and the revenue. That was there before at point b. But has been lost so that pink rectangle represents the decrease in total revenue. The bluish purple periwinkle color.
The price effect that it represents the increase in total revenue. So again. We have price and quantity effect working in opposite directions. So this just summarizes that after a price increase.
The price effect says that each unit sold sells with a higher price. Which would raise revenue. The quantity effect says that when the price increases. Fewer units are sold which lowers revenue.
So what s going to tell us. Which one of those two effects wins out the answer is the price elasticity of demand. So that s going to determine which effect is stronger is the quantity effect or the price effect going to be the dominant one so let s look at three specific examples of this now ok so our first one is going to be unit elastic. If you recall with unit elastic bendings that s the change in quondam and it over the change in price is equal to 1.
So quantity effect and price effect. In this instance are exactly equal. So let s look at this going from point a to point us..
Where fte. It doesn t really matter. Which one we do let s start at point e price is 3. The quantity demanded is 10.
So it is our total revenue. 3. Times 10 equals. 30.
Now we re going to lower our price. So we have a downward movement along the demand curve to point f price. All the way down to 1 and our quantity. Demanded.
Now has increased to 30. So 1 times. 30. Equals.
30. In either case. Our total revenue is exactly the same so with unit elastic demand. Neither the quantity us ignore the price effect dominates.
The other they are exactly equal. So there is no change in total revenue. Regardless of whether you re increasing the price or decreasing. The price.
An elastic demand alright so remember when we re talking about inelastic demand. We have that steeper demand curve as you can see over here to the right and the idea here is that when the price changes yes our quantity demanded will change. But not by very much these are goods that typically we aren t very responsive to a change in the price things like gas if gas prices increase. We still need gas.
We might get a little less gas because maybe we won t take that road trip. If gas is really cheap. Maybe we will drive a little bit more we ll leave the car on or something like that but typically speaking gas..
The demand for gas is relatively inelastic. So that s a good example to think of when we picture this so we have a price here. At point a the price is 10. The quantity demanded is 30.
So our total revenue price times. Quantity. 10 times 30 equals 300. Now we have a downward movement to 5.
And we see that our quantity demanded has indeed increased but not by very much it s only gone from 30 to 40. So we have 5 times 40. Equals 200. So they ve cut their price in half.
And they have actually decreased their total revenue. Because demand is inelastic so in this case having a higher price. When you have inelastic demand actually increases total revenue. Because the price effect is the stronger of the two effects.
So if we were to go from b to a increase the price from five to ten dollars in that case. We would actually be going from revenue of 200 to 300. So with an elastic demand producers have an opportunity to increase the price. And it will actually lead to an increase in revenue because people will mostly keep buying their product and if they cut the price people aren t going to buy a whole lot more so they do better off with a higher price elastic is the opposite.
We have that more shallow less steep demand curve. This is where people are highly responsive to changes in the price. So we re going to start at five dollars again price being five dollars budget sort of four because we do up arrows on down. There so let s do that so we re going to start at four dollars and at four dollars our quantity demanded is fifty so four dollars times.
Fifty equals two hundred dollars then we re going to increase the price. But what we notice is we increase price from 4 to 5. It has a very large effect on our quantity. Demanded.
This is the quantity effect taking place. We go from 52 down to 20 units. Demanded..
So now we re at total revenue is 5 times. 20. Which equals 100. So our revenue has been cut in half as a result of a relatively small 25 price increase.
So people were very responsive to the change in the price. So as a result when demand is elastic. We have a lower price is what is needed to increase total revenue higher prices reduced total revenue. Because that quantity effect is the stronger of the two last thing to note is that elasticity generally changes along the demand curve.
So i know i ve given you examples of what they look like more steep or shallow. But in reality as you move along the demand curve. We go from the top portion. Where demand is typically you a stick and you could do the math to prove this to yourself.
And maybe we ll in class. Then you hit a center point. Where it becomes exactly unit elastic. So at that point you could increase the price or decrease.
The price. And it s not going to change tool revenue and a small little region right there in this case. At five dollars and then demand becomes inelastic towards the bottom. And the reason for that again is that we are calculating percent changes.
So going from ten dollars to nine dollars that s only a 10 decrease in. Price but going from essentially like 01. As the quantity demanded up to one that s a massive increase in the quantity. Demanded.
So it s going to be demand will be elastic in that range and elastic at the bottom range. This has been of the money production. ” ..
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