PED and total revenue

1. Whether a price change raises or lowers total revenue depends on the price elasticity of demand.
2. This makes PED central to a firm's pricing decision and to a government deciding what to tax.

How PED drives revenue

1. Inelastic demand
   1. Quantity falls proportionately less than price rises, so the gain in revenue from the higher price outweighs the loss from fewer units, and total revenue rises. This is why a tax on petrol or cigarettes raises large revenue: demand barely falls.
2. Elastic demand
   1. Quantity falls proportionately more than price rises, so the loss from fewer units outweighs the gain from the higher price, and total revenue falls. A single brand of biscuit behaves this way, since buyers desert it for rivals.
3. Unit elastic demand
   1. The two percentage changes are equal, so total revenue is unchanged and is at its maximum where PED equals 1 in size.

The revenue rule

1. When demand is inelastic, price and total revenue move together.
2. When demand is elastic, price and total revenue move in opposite directions.
3. When demand is unit elastic, total revenue is unchanged and is at its maximum.

Applying it to pricing

1. A firm facing inelastic demand, such as a rail operator on a commuter route, can raise price to raise total revenue.
2. A firm facing elastic demand, such as one airline on a competitive route, should consider cutting price to raise total revenue.
3. Knowing PED turns pricing from guesswork into a calculated decision.

Beyond revenue

1. Revenue is not the same as profit, which also depends on costs, so a revenue-maximising price need not maximise profit.
2. PED often varies along the demand curve, so the rule can change with the price charged.
3. Firms also weigh long-run effects such as customer loyalty, not just immediate revenue, so it depends on the firm's objective.

Should a firm rely on the PED and revenue rule when setting price?

1. The rule is a dependable starting point, because it follows directly from the fact that total revenue is price multiplied by quantity: once a firm knows whether demand is elastic or inelastic at its current price, the direction in which to move price to raise revenue is clear.
2. But higher revenue is not the same as the firm's true goal: revenue ignores costs, so the revenue-maximising price where PED equals 1 in size rarely coincides with the profit-maximising price, and a firm chasing revenue alone can lift turnover while shrinking profit.
3. The rule also assumes a known and stable PED, yet elasticity varies along the demand curve and rivals may react, so a price cut expected to lift revenue can fail if competitors match it or if the firm has misjudged its current elasticity.
4. On balance, the PED and revenue link is a sound first step but not a complete pricing rule, so it depends on the firm's objective, its costs and the reliability of its elasticity estimate: it is best used alongside cost and competitor analysis rather than on its own.