Now let's see how elasticity and demand relate to the concept of revenue. So revenue is the money that's coming in as companies sell stuff, right? When we sell stuff, we're going to get revenue and we're going to calculate our revenue or should I say our total revenue. Our total revenue is just going to be the simple calculation of price times quantity, right? So how much did we sell times at what price did we sell it? That's our revenue that we brought in, right? We sell 100 units for $10 each, our revenue was $1,000 (100 times 10). So we're going to use what's called the total revenue test when we're analyzing our changes in price. So what we want to do pretty much all the time in economics is maximize our revenue, right? We want to bring in as much money as possible, so we want to find the right price combination with demand that's going to do that for us, right? So we want to maximize total revenue, we need to find that point. For example here, I've got this point on the graph where we've got a price of $50 and demand quantity demanded at that price is 1,000 units. So let's go ahead and calculate total revenue in this case, right? Our total revenue, pretty easy, our price of $50 times our quantity of 1000, we're going to get total revenue of $50,000 right? So that's how we calculate total revenue. Pretty easy. You can also just calculate it on the graph as the area of this rectangle right here, which would just be the 50 times the 1,000, right? Pretty simple. That's our total revenue and that's how we see it on the graph.
So let's go ahead and see how a change in the price, right? Right now we have a price of 50, but what if the price was different? What if we were to increase or decrease the price? How is that going to affect our total revenue? Well, when we change the price, we're going to have 2 effects on total revenue. The first we're going to call the price effect, right? And this is the change in our total revenue based on it being a different price, right? Being selling the units at a different price. So the idea is let's say we increase our price. We're going to sell the units that we sell at a higher price, so we're going to make more money per unit because of this price effect, right? Because of the increased price and vice versa, right? If we decrease the price, we would make less money per unit, based on this and that would be the price effect. Compared to the quantity effect, right, so let's say we did have that increase in price, right? Well when we increase the price, we could expect quantity demanded to decrease, right? So we're going to sell stuff at an increased price, that's the price effect, but we're going to sell less stuff, that's the quantity effect, right? Or the opposite. If we decrease the price, we're going to sell it at a less price, the price effect, but we're going to sell more stuff, the quantity effect. Let's go ahead and see how that looks on the graph. I'm going to have 3 sections here. I'm going to label it section 1 over here, section 2, and section 3 of this graph. So let's go ahead and talk about the price effect and the quantity effect in this situation. So remember, we had originally a price of $50 and a quantity demanded of 1,000. Now management says, hey I want to make more money, let's raise the price to $60. So at this price of $60 they're like yeah we're going to make more money, except they forgot that when you raise the price, you're going to have less quantity demanded, right? So this higher price of $60 caused quantity demanded to drop from 1,000 to 800, right? So let's see where the price effect and where the quantity effect are. So first let's talk price effect. Price effect is going to be this box 1, right. This area of box 1 is the price effect in this situation. The idea is that we're gaining this much in revenue because we increase the price, right? We're going to get more revenue because we increase the price. We're going to get more revenue per unit sold, I should say, right? So for each unit we sell, we're going to get more money. $60 per unit instead of $50. That's the price effect - that extra $10 per unit gives us this little green area right here, but let's counter that with the quantity effect, which is in box or yeah box 3 here. That is going to be our quantity effect and remember since we increased the price, we made more money per unit, right? We made an extra $10 per unit, but we didn't sell 1,000 units anymore. Now we sold only 800 units. So there's the quantity effect is that we actually lost revenue because we're not selling as many units as before. So that's going to counteract the price effect where we got more money for each unit. Unfortunately, we didn't sell as many units so there's going to be a balance here And the idea is which one was bigger? Was the price effect bigger than the quantity effect? That would have been a good thing for us, right? Because we increased the price, we wanted the price effect to be big. We want to make more money per unit and that to outweigh the units that we lost. So let's go ahead and calculate our total revenue in each case and let's see if it was actually a good idea for management to raise the price. So let's start here with our original situation which we calculated above and this was when our price was $50 right? At that price of $50, our total revenue was $__PĂ—Q__$, price being 50. Our quantity was 1,000 in that situation and at that price and quantity, we had $50,000 in total revenue and now let's see in the new situation what happens. So in our new situation, we raise the price to $60 right? And at this price of $60 let me just scoot out of the way here. At this price of $60, what was our total revenue? We sold them for 60 but we didn't sell 1,000 this time. We only sold 800. So 60Ă—800, that's going to give us $48,000 in total revenue. So in fact our total revenue decreased because of this price increase, right? So we could say that the quantity effect in this situation was bigger than the price effect and you can kind of verify that on the graph by seeing that the area of number 3 is bigger than the area of number 1 and you can kind of do it just by counting basically the boxes in the area. You can kind of see that it's a bigger area there, but anyway the idea here is that the total revenue has decreased, so let's go ahead and define our elasticity based on what's happened to total revenue. So here we go. If this is the total revenue test right here, if total revenue increases when price increases, demand is inelastic. Alright and the way I like to remember that is we've got total revenue increases, price increases inelastic, right. We've got that kind of sequential thing going there, but I do want to note that everything here works and vice versa. So although that's true, at the same time if total revenue decreases when price decreases then we're also inelastic right? So in both those situations, it's still inelastic. So just want to be careful with these vice versa that pop up all through economics. So let's go on to the next one. When total revenue decreases as price increases, this is elastic in this situation. Okay? And remember it's also the opposite. So if we were to have total revenue increasing when the price is decreasing, we would also have an elastic situation. And last but not least, if total revenue stays the same when price increases, demand is unit elastic, right? So that is going to be our last situation there. So what did we see in this graph? Was demand elastic or inelastic? Well, we raised the price and total revenue decreased, right? So if you look at our options there, that's going to tell you that demand was elastic, right? It shows that the quantity effect was bigger than the price effect, right? The quantity demanded decreased more than the price was increasing, right? So, in the end, we have an elastic situation there on the graph at that point. Cool, so let's go ahead and go on to the next video at this point.
