Total Revenue TestUses elasticity to show how changes in price will

affect total revenue (TR). (TR = Price x Quantity)

Elastic Demand- • Price increase causes TR to decrease• Price decrease causes TR to increase

Inelastic Demand- • Price increase causes TR to increase• Price decrease causes TR to decrease

Unit Elastic-• Price changes and TR remains unchanged

Ex: If demand for milk is INelastic, what will happen to expenditures on milk if price increases?

Is the range between A and B, elastic, inelastic, or unit elastic?

A

B

10 x 100 =$1000 Total Revenue

5 x 225 =$1125 Total Revenue

Price decreased and TR increased, so…

Demand is ELASTIC

125%

50%

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• Elastic and Inelastic Demand Baby– Winner 2013 Econ video contest

3

Total Revenue Test

Total Revenue Test

}inelastic

} unit elastic

}elastic

Elasticity Practice

8

• Graph the following chart• Calculate the Ed using the top set

of numbers and prices rising

Answers -Graph• This is what your graph should look

like

Answers - Ed

• Ed = % change in quantity demanded of product X

% change in price of product X

% Change in quantity = nqd – iqd initial quantity

demanded % Change in price = New Price – Initial

Price Initial price

Ed = (90 – 100) ÷ 100 ($2 - $1.00) ÷ $1.00

• Ed = -.10 = -.1 1

Drop the negative: Ed is < 1 therefore the demand for is INelastic

• Calculate the TR and determine if Total Revenue increased or decreased with a price increase

• What is gain or loss on price move?

Answers

• $3 * 70 = $210

• $2 * 90 = $180

• Total Revenue increased $30

What Happens If ---

• Graph the following chart• Calculate the Ed using the bottom

two numbers and prices rising

Answers - Ed

• Ed = % change in quantity demanded of product X

% change in price of product X

% Change in quantity = nqd – iqd initial quantity

demanded % Change in price = New Price – Initial

Price Initial price

Ed = (40 – 70) ÷ 70 ($4 - $3.00) ÷ $3.00

• Ed = -.4285 or 42.85% = 1.28

.3333 or 33.33%

Drop the negative: Ed is > 1 therefore the demand for is elastic

Ed & TR Test “quiz”

Practice Problem

• See handout

Consumer and Producer Surplus

• Consumer Surplus– Difference between maximum

price willing to pay and the actual price producers charge

– Think of it as a “willing to pay” curve

18

Marginal Benefit & Surplusses

• Marginal Benefit– What you gain when you get one

more unit– Measured by what you are willing

to give up– Everyday life we say “getting

value for our money”– There is a difference between

value and price

Value vs. Price

• Value is what we get• Price is what we pay

• Everyday idea of value is marginal benefit

OR• The measure of the maximum

price what consumers are willing to pay for another unit of a good or service

Pizza Sales Per Slice

P

D

2

1.5

$1

.5

20 30 40 10

Consumer Surplus

Amount Paid

Market Price

Consumer surplus from 10th slice of pizza

Willing to pay

Voluntary ExchangeIn the free-market, buyers and sellers

voluntarily come together to seek mutual benefits.

22

Voluntary ExchangeIn the free-market, buyers and sellers voluntarily

come together to seek mutual benefits.

23

Voluntary ExchangeIn the free-market, buyers and sellers voluntarily

come together to seek mutual benefits.

24

Voluntary ExchangeIn the free-market, buyers and sellers voluntarily

come together to seek mutual benefits.

25

Example of Voluntary Exchange

Ex: You want to buy a truck so you go to the local dealership. You are willing to spend up to $20,000 for a new 4x4. The seller is willing to sell this truck for no less than $15,000. After some negotiation you buy the truck for $18,000.

Analysis:

Buyer’ Maximum-

Sellers Minimum-

Price-

Consumer’s Surplus-

Producer’s Surplus-

$20,000

$15,000

$18,000

$2,000

$3,00026

Consumer Surplus is the difference between what you are willing to pay and what you actually pay.

CS = Buyer’s Maximum – Price

Producer’s Surplus is the difference between the price the seller received and how much they were willing to sell it for.

PS = Price – Seller’s Minimum

Voluntary Exchange Terms

27

S

P

Q

D

Consumer and Producer’s Surplus

$10

8

6$5

4

2

1

10 2 4 6 8

CS

PS

30

Calculate the :1. Consumer Surplus2. Producer Surplus3. Total Surplus

Calculating Consumer Surplus

In DollarsMax

Willing to pay

Actual price (E)

Calculate CS

$9 $5 9 – 5 = $4

$8 $5 8 – 5 = $3

$7 $5 7 – 5 = $2

$6 $5 6 – 5 = $1

$5 $5 5 – 5 = $0

31

Sum = CS = $10

Calculating Producer Surplus

In DollarsMin Price charged

Actual price (E)

Calculate PS

$2 $5 5 – 2 = $3

$3 $5 5 - 3 = $2

$4 $5 5 - 4 = $1

$5 $5 5 – 5 = $0

32

Sum = PS = $6

Surpluses

• Could be calculated in Quantity

33

Summary

Consumption Inefficiency

ProductionInefficiency

Practice ProblemName of Consumer Price willing to pay

Matt $20

Don $15

Sarah $8

George $12

Ann $7

Q. If dinner sells for $10, what is the value of Dons’ consumer surplus?

Practice ProblemName of Consumer Price willing to pay

Matt $20

Don $15

Sarah $8

George $12

Ann $7

Q. If dinner sells for $10, what is the value of Dons’ consumer surplus?

A. Willing to pay is $15. Market price is $10. Willing to pay ($15) – Actual Price ($10) = $5

Practice ProblemName of Consumer Price willing to pay

Matt $20

Don $15

Sarah $8

George $12

Ann $7

Q. If dinner sells for $11, what is the TOTAL value of consumer surplus?

Practice ProblemName of Consumer Price willing to pay

Matt $20

Don $15

Sarah $8

George $12

Ann $7

Q. If dinner sells for $11, what is the TOTAL value of consumer surplus?

A. 20 – 11 = 9, 15 – 11 = 4, 12 – 11 = 1

9 + 4 + 1 = $14 consumer surplus

• For a given linier demand curve, the value of consumer surplus does what as market price increases?

• For a given linier demand curve, the value of consumer surplus does what as market price increases?

• Decreases as market price increases

(1)Price

(2)QA

(3) 

(4)QB

(5) 

(6)QC

(7) 

$10 100 $_____ 100 $_____ 100 $_____

9 111 _____ 130 _____ 110 _____

8 125 _____ 170 _____ 120 _____

7 143 _____ 220 _____ 130 _____

6 167 _____ 280 _____ 140 _____

5 200 _____ 350 _____ 150 _____

41

15. A marketing firm has done a study of market demand for DVDs of three different movies. Calculate the total revenue for each movie in columns 3, 5, and 7.

Without calculating the price elasticity of demand, indicate whether demand for each movie is elastic, inelastic or unit-elastic. For which movie would a reduction in price produce the greatest increase in revenue?

(1)Price

(2)QA

(3) 

(4)QB

(5) 

(6)QC

(7) 

$10 100 $1000 100 $1000 100 $1000

9 111 999 130 1170 110 990

8 125 1000 170 1360 120 960

7 143 1001 220 1540 130 910

6 167 1002 280 1680 140 840

5 200 1000 350 1750 150 750

42

Without calculating the price elasticity of demand, indicate whether demand for each movie is elastic, inelastic or unit-elastic. For which movie would a reduction in price produce the greatest increase in revenue?

Applying the total revenue test, we see that total revenues remain approximately constant for movie A, meaning that demand is unit-elastic. Total revenues for movie B are increasing as price decreases, meaning that demand for movie B is elastic. Total revenues for movie C are decreasing as price decreases, meaning the demand for movie C is inelastic. [text: E pp. 77-80; MA pp. 77-80; MI pp. 77-80]