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IAI Actuarial Core Principles · Business Economics · Production, costs, revenue and profit in price and output decisions

For a firm facing a downward-sloping demand curve, what happens to total revenue when price is cut and demand at that point is price inelastic?

Total revenue falls because marginal revenue is negative. When demand is price inelastic, a price cut raises quantity by a smaller percentage than the price falls, so each extra unit sold reduces total revenue overall.

  1. ATotal revenue rises because quantity rises proportionately more
  2. BTotal revenue is unchanged
  3. CTotal revenue falls because marginal revenue is negativeCorrect
  4. DTotal revenue rises because marginal revenue is positive
  5. Total revenue falls only if average revenue is below marginal cost

Explanation

With inelastic demand, the percentage rise in quantity is smaller than the percentage fall in price, so total revenue falls. That means marginal revenue is negative in the inelastic range. Revenue is unchanged only at unit elasticity.

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