Question

How can we explain the following scenario using​ the​ own-price elasticity​ of​ demand? You only need to specify whether demand is inelastic or elastic and how you know. A fall in input prices has led to higher output of​ ​ Mercedes-Benz. But total revenue for​ the​ Mercedes-Benz Company has declined as a result.

Answer 1

Solution:-

A fall in the input prices has led to higher output of Mercedes Benz. But total revenue for the Mercedes Benz company has declined as a result.

It means that demand is inelastic.

Explanation:

Suppose the price of a commodity falls from P to P1 and in the response to it the quantity demanded increases from Q to Q1.

Since the total expenditure on a good( T.E)= P.Q

With the fall in price of input the total expenditure on it declines ,price elasticity will be less than one because as the decline in expenditure (-∆PQ) due to fall in price (-∆P) exceeds the gain in expenditure (+∆QP) due to increase in quantity demanded (+∆Q) .

Thus , we have

∆QP< ∆PQ

Rearranging we have.

∆QP/∆PQ<1

Now as seen above , ∆Q.P/∆P.Q measures the price elasticity of demand.It follows therefore that if the total expenditure decreases

∆QP/∆PQ= ep<1

Note: Total expenditure on goods made by the consumers is revenue for the sellers.