Question

1. Seeing the price gasoline has fallen, an observer of the oil maket made the following remark: "the total amount of money spent buying gasoline is going to fall since the price of gasoline is lower now." Is he correct? Why or why not?

2. A used car dealer finds that the price elasticity of his cars is ?0.77. He wants to hold a sale to get rid of his inventory. What will you advise him?  

Answer 1

(1)

In general, gasoline comprises a considerable proportion of consumer budget and so, demand for gasoline is elastic. With elastic demand, a decrease in price leads to a more-than proportionate increase in quantity demanded, so total expenditure increases. Therefore the statement is incorrect.

However, if it is found that gasoline has inelastic demand, in that case a decrease in price will lead to a less-than proportionate increase in quantity demanded, so total expenditure will decrease. In that case the statement is correct. Exact answer depends on the value of price elasticity of demand for gasoline.

(2)

Since absolute value of price elasticity is less than 1, demand is inelastic. For inelastic demand, a decrease in price will decrease total revenue and therefore, the sale is not advisable.