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CA Foundation · Business Economics · Theory of Demand and Supply

A company finds that a 10% rise in the price of its packaged juice reduces the quantity demanded by 20%. A reduction in price will therefore have what effect on the firm's total revenue, other things remaining the same?

Total revenue will rise. The elasticity is 20% divided by 10%, which equals 2, so demand is elastic. With elastic demand, quantity responds proportionately more than price, so cutting the price increases total revenue.

  1. ATotal revenue will rise, because demand is elasticCorrect
  2. BTotal revenue will fall, because demand is elastic
  3. CTotal revenue will rise, because demand is inelastic
  4. DTotal revenue will remain unchanged, because demand is unitary elastic

Explanation

Price elasticity = 20/10 = 2, which is greater than 1, so demand is elastic. When demand is elastic, price and total revenue move in opposite directions. A price cut therefore raises total revenue. Option 3 wrongly treats the demand as inelastic.

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