Discuss whether or not a firms revenue would increase, in response to price and income changes, if the price elasticity and income elasticity of demand for its product became highly elastic. [12]

In terms of price elasticity of demand, a highly elastic price elasticity of demand means that the consumers are very responsive to changes in the price of the product, as such, if the price of the product falls, the firm can expect a disproportionate increase in consumption and, as such, an increase in total revenue. However, if the price of the product increases, the firm should expect their total revenue to fall as consumers will consume substantially less than before, which would lead to an overall fall in revenues as the increase in price would not make up for the fall in the quantity consumed. Also of note is the magnitude of the price change. Usually, the price elasticity of products varies with price, as such, a fall in price may only be able to increase revenues to an extent, because as the price begins to fall, the price elasticity of demand is likely to begin falling. This is because as the price of the product decreases, the purchase takes up a smaller proportion of the consumer’s income, thus it becomes a less significant purchase and in turn, it causes less time being dedicated to making the purchase and as such the price becomes less significant, thus lowering the price elasticity of demand. The opposite is also likely to be true for an increase in price. As such, the rate at which revenue falls with an increase of the price is likely to increase as well together with the price. This is due to the fact that as price increases the purchase becomes an increasingly significant purchase, in turn causing consumers to become more price conscious, thus increasing the price elasticity of demand.

Income elasticity wise, the fact that the demand is highly elastic is insufficient information to determine whether the firm would experience an increase or fall in revenue relative to a change in income as, alongside the elasticity, we need to know whether the value of the YED is positive or negative. A high positive value will indicate a superior good. This would mean that as income increases the demand for the good increases disproportionately, meaning that as customers have more money, they purchase more and more of the product. Thus, if the YED is a high positive value, the firm can expect their revenues to rise with a rise in income and fall with a fall in income. However, if the YED is a high negative value, then this would indicate an inferior good meaning that the firm should expect a strong inverse correlation between the quantity demanded. Thus, if income falls, they should expect and increase in revenue and a fall in revenue if income increases.

Overall, given a highly price and income elastic product, the firm can expect a raise in revenue if the price falls; and, if the income elasticity is negative, they can expect a raise in revenue with a fall in incomes, while if the value is positive, they can expect a raise in revenue with a raise in incomes.