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 ?

Price elasticity

Explanation:

The company needs to check that the elasticity of demand is such that a decrease in the price would result in increase in the demand for the cars and trucks. Only when the demand is elastic, a cut in price would result in increase in demand for cars.

Here we can recall the concept of price elasticity which measures the responsiveness of change in demand of a commodity (in our case cars and trucks) due to change in the price of that commodity.

Ed= % change in quantity demanded / % change in price â¦.(1)

= (â²Q/Q)*100 / (â²P/P)*100

Here â²P refers to change that is difference between the price before cut and price after cut; similarly â²Q refers to change in quantity demanded for cars and trucks before price cut and after the price cut.

After simplification, we get

= (â²Q/â²P) (P/Q)

We can clearly notice in the formula (1) that if 1 % change in the price of car results in more than 1 % change in the demand for cars, the price cut is justifiable and profitable for the company and will lead to increase in the revenues for the company.

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