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THE ANALYSIS OF DEMAND AND PRICE EFFECT ON FIRM’S REVENUE

Anna Križanová, Martin Hrivnák

The significance of revenue management is apparent in this time. A firm can manage its costs, so it is possible to
influence its revenues to some extent. The article points on some instruments, which can be used by management. The
goal is the use of price demand elasticity effect. A management should know this factor to decide on change of price and
then change of revenues.
Key words: cost management, revenue determinants, demand elasticity.

1. Determinations of a firm’s revenue

There are numerous different opinions on identification revenue, thus it is necessary to define this
properly.
The revenue makes up the prime part of firm’s yields. It is obvious not only in production of goods but
also in service sector. They mean money, which the firms gain through selling their goods and services in a
particular accounting year. They make up main financial source of the firm, which uses it for paying fees,
taxes, costs, and dividends and as an instrument of extended reproduction.
Revenues are receipts from selling of produced goods and provided services, purchased goods and
stocks, useless assets, patents and licences, etc. The value of particular terms is recorded in profit and loss
account.
The revenue of produced goods or/and provided services is of great importance. It is determined by the
volume of sale, prices of particular products, variety of products, way of invoicing and period of payment and
other factors.
The firm may influence the volume of sale, but to large extent it is limited by production capacity and
demand. Prices are results of interaction of demand and supply. They are affected by a structure of a market,
thus the firm can influence them only to some extent. But the variety of goods lies in the firm hand so its
revenue may be affected by its optimisation. The way of invoicing is established by the law, thus it cannot by
affected by the firm.
The firm can raise its revenue by increasing of volume of sale and prices of products, improving their
quality and technical level, introducing new goods, improving customer services, introducing more effective
advertisement and etc. These factors are subject of marketing policy, but addressing these factors is beyond the
scope of this paper. The following analysis will cover these issues:
dependence of revenue on demand – volume of sale and prices,
dependence of revenue on price elasticity of demand

2. Effect of change in price and volume of sale on change in revenue

The sole formula for calculation of revenue offers two ways of influencing their amount:

R = Q. p
Where: R – receipts,
Q - volume of sale,
P – price.
The influence of these factors will be analysed further in the text.

Change in revenue as a result of change in price on the condition ceteris paribus

This case can be supposed as hypothetical. Only rarely the change in price is not attended by the change
in demanded quantity of goods. If this were a case, the change in price of a good will be followed by no effect
on demanded quantity of goods. This means that there is a linear relationship between change in revenue and
change in price of a good.

Change in revenue as a result of change in volume of sale on the condition ceteris paribus
This situation can be supposes as realistic. The management of a firm is able do decide on the quantity
supplied if the market requires it. Of course, the decision must reflect condition in the relevant market, so that
the market could absorb increased supply. The change in the volume of sale may be cause either by customers,
by increasing their demand, or by the firm, by improving its application of instruments of marketing mix such
as product, distribution, communication, processes, environment, custom services and human factor.
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Change in revenue as a result of both change in volume of sale and change in prices
This is the most frequent case. Usually the change in price causes the change in volume of sale, and so
change in revenue. Management of a firm should constantly monitor the responsiveness of environment to
change in both price and quantity demanded by customers, in other word to monitor demand for its good.
The management of the firm needs information on condition in the market and price elasticity of
demand.

3. Effect of price elasticity of demand on change in a firm’s revenue

Before we start analysing effect of price elasticity of demand on change in a firm’s revenue, it is
necessary to analyse the price elasticity of demand itself.
The measure of the responsiveness of quantity demanded to a change in price is the price elasticity of
demand. It is the ratio of the percentage change in the quantity of a good demanded to a given percentage
change in its price.
E = percentage change in the quantity demanded / percentage change in its price

The ratio determines the nature of a demand. It helps to a management of a firm in advance to estimate
with some accuracy the change in its revenue as a response to the change in price.

The nature of the demand

According to the value, which the ration can reach, we can define the following types of demand:
perfectly elastic demand: E = .
It is a very theoretical case. Above the market price no units of the good can be sold. At the market price,
supplier can sell as much of the good as they want without further price reduction. It is a situation in which the
demand curve is a vertical line (Fig..1.)
elastic demand: E > 1.
It is relatively common case. A situation in which quantity demanded changes by a larger percentage
than price. This case is shown in the Figure 2.
unit elastic demand: E = 1.
A situation in which price and quantity demanded change by the same percentage. This case is shown in
Figure 3.
inelastic demand: E < 1.
It is also a relatively common case. A situation in which quantity demanded changes by a smaller
percentage than price. This case is shown in the Figure 4.
perfectly inelastic demand: E = 0.
No matter what the price, the quantity demanded is always same. It is a situation in which the demand
curve is a horizontal line (Fig. 5).

Determinants of elasticity of demand

the existence of a close substitute causes that demand for the good tends to be elastic,
the longer lifespan and durability of a good the more elastic demand for it is,
the urgency of a good causes that the demand for it is more inelastic,
uniqueness of a good causes that the demand is more inelastic,
portion of a person’s budget spent on a good, the larger the portion, the more elastic demand is,
the existence of complements, if something is a minor complement to an important good, its demand
tends to be inelastic,
time, demand often is less elastic in the short run than the long run,
the influence of a quality of a product makes the demand more elastic.
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c c c

Q Q Q

Fig.1. Perfectly elastic demand Fig.2. Elastic demand Fig.3. Unit elastic ddemand

c c

Q Q

Fig. 4. Inelastic demand Fig.5. Perfectly inelastic demand

Effect of price elasticity of demand on a firm’s revenue

After the analysis of price elasticity of demand we can identify the relationship between the price and
firm’s revenue.
Managers very often consider possibility of decreasing a price of firm’s good in order to increase its
revenue. The rule decrease the price in order to increase revenue does not always hold. The nature of the
demand can cause that decreasing of the price will lead to decreasing firm’s revenue. How will revenue change
at different nature of demands?

Revenue and elastic/inelastic demand

Increasing of revenue caused by:
decreasing of price of a good for which is elastic demand. Small decrease in price causes relatively
greater increase in quantity demanded which will finally result in increase of revenue.
increasing of price of a good for which is inelastic demand. Increase in price causes relatively
smaller decrease in quantity demanded which will finally result in increase of revenue.
Decreasing of revenue caused by:
increasing of price of a good for which is elastic demand. Increase in price causes relatively greater
decrease in quantity demanded which will finally result in decrease of revenue.
decreasing of price of a good for which is inelastic demand. Great decrease in price causes relatively
smaller increase in quantity demanded which will finally result in decrease of revenue.

Revenue at a unit elastic demand

A situation in which price and quantity demanded change by the same percentage and total revenue
therefore remains unchanged as price changes. For this reason increasing or decreasing of a price has no
influence on change in revenue. Revenue develops proportionally with change in the price.
The influence of price elasticity of demand on change in revenue is very important information for a
management of a firm, who tries to increase them. Thus it is necessary for the management to have adequate
amount of information, generated by its information system, on relevant market of its product, on demand and
its customers.
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Conclusions
The paper deals with the issue of price elasticity of demand and points out factors determining it. The
paper highlights importance of knowing it for a management of a firm, because it significantly influences the
firm`s revenue and so its success on the market.
This article is a partial outcome of the research grant VEGA þ. 1/2567/05: Marketing activities of public
road a rail enterprises - participants of an integrated transport system in the process of formation of their
supplies.

REFERENCES
1. Cisko, Š., Birnerová, E.: Costs in road transport, the1st. edition, EDIS ŽU Žilina, 2000, 96 p.
2. Križanová, A., Birnerová, E.: Marketing mix in road transport, EDIS ŽU Žilina, 2002, 157 p. ISBN 80-7100-949-0