Total-Revenue Test
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What Is Total-Revenue Test?
The total-revenue test is a shortcut for judging elasticity from the way total revenue responds to a price change. Total revenue equals price times quantity sold. When demand is inelastic, a price increase raises total revenue, because quantity demanded falls proportionally less than price rises. When demand is elastic, a price increase lowers total revenue, because quantity falls proportionally more than price rises. When demand is unit elastic, total revenue does not change. On a standard downward-sloping straight-line demand curve, total revenue is maximized at the point where demand is unit elastic, the midpoint where elasticity equals 1 in absolute value.
Why It Matters
The total-revenue test connects the abstract elasticity coefficient to a decision sellers care about: how a price change affects the money they take in. A firm facing inelastic demand can raise revenue by raising price, while a firm facing elastic demand raises revenue by cutting price. This is why the test is a staple of pricing strategy and exam questions alike. It also illuminates the shape of a straight-line demand curve, where demand is elastic at high prices, inelastic at low prices, and unit elastic in the middle, so revenue peaks at the midpoint. Understanding the test helps students reason about monopoly pricing, tax policy, and any situation where quantity and price move together to set revenue.