Final answer:
When the price of a good increases and total revenue falls, this indicates that the demand for the good is elastic. An elastic demand means that the percentage change in quantity demanded is greater in response to a change in price than the change in price itself. Understanding elasticity helps businesses make informed pricing decisions to maximize revenue.
Step-by-step explanation:
If the price of a good rises and as a result total revenue falls, it must be true that the demand for the good is elastic. Price elasticity of demand indicates how responsive the quantity demanded of a good is to a change in its price. In the case of an elastic demand, quantity demanded changes by a greater percentage than the price does, which means that if the price increases, the decrease in quantity demanded will be relatively large, causing total revenue to fall. Conversely, if the demand were inelastic, an increase in price would lead to a smaller percentage decrease in quantity demanded, which could result in total revenue increasing.
Elasticity is generally divided into three categories: elastic (with elasticity greater than one), inelastic (with elasticity less than one), and unitary (with elasticity equal to one). When the elasticity is greater than one, any price increase leads to a proportional decrease in quantity demanded that is larger than the price increase, therefore reducing total revenue. This concept is critical for businesses to understand as they make pricing decisions, since it affects the total revenue they can expect from selling their goods or services.