Question

Ford Motor Company announced a major rebate program for its cars and trucks. The rebate program amounts to a simple reduction in price. The company executives hope to increase revenue as a result of this rebate program.  

What economic explanation would justify this decision ?

Answer 1

One of the economic reasons as to why company executives think that the revenue will increase as a result of the rebate programs is because according to their information the demand for automobiles is elastic.

We will try to understand this through the relationship between price and consumer's total expenditure.

We know that Elasticity measures the percentage change in quantity due to percentage change in price. and for elastic demand,the percentage change in quantity is greater than percentage change in price. Also the Total Expenditure(TE) is price times quantity. So any change in total expenditure can be due to both changes in price and quantity.So a lower price reduces the TE, but a larger quantity increases it.

Since in the case of elastic demand, percentage change in price is lower than percentage change in quantity.therefore quantity wins the race here and thus total expenditure increases as a result for a good with elastic demand.

This total expenditure by all the consumers is the Total Revenue for the company (Ford in this case).This is a basic reason why the executives expect revenue to rise as a result of fall in price due to rebate.