A firm sells a product with a price elasticity of demand of −2.5. The firm raises its price by 4%. Which of the following correctly describes the effect on the firm's total revenue?

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Question

A firm sells a product with a price elasticity of demand of −2.5. The firm raises its price by 4%. Which of the following correctly describes the effect on the firm's total revenue?

Accepted Answer

Total revenue falls because the percentage fall in quantity demanded exceeds the percentage rise in price — Award 1 mark for correct answer. With PED = −2.5, demand is price elastic (|PED| > 1). A 4% price rise leads to a 10% fall in quantity demanded (2.5 × 4%). Since the percentage fall in quantity demanded (10%) exceeds the percentage rise in price (4%), total revenue falls. A describes the outcome for inelastic demand, which is the opposite situation. B would only apply if PED = −1 (unit elasticity). D incorrectly introduces the concept of supply, which is not relevant to this analysis.

Answer

Total revenue falls because the percentage fall in quantity demanded exceeds the percentage rise in price

Answer

Total revenue stays the same because the percentage changes cancel out

Answer

Total revenue falls because supply decreases when price rises

Answer

Total revenue increases because the price rise is larger than the fall in quantity demanded

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