If the price of a commodity increases by 20%, its demand drops by 20%. Then how it will affect the expenditure?
Answer & explanation
Correct answer: option 3
The correct answer is Option (3) → No change in expenditure.
Note : The given answer is as per NTA and NCERT. However, the above table discusses the concept of relationship between elasticity and change in expenditure of a commodity. In the given question, the concept of elasticity is not referred to. In strictest terms, the answer of this question should be Option 1 : Decline in expenditure as explained below:
Let $P_0$ and $Q_0$ be the initial price and demand, and $E_0$ be the initial expenditure.
The changes are:
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Price increases by 20%: $P_1$= $P_0$×(1+0.20)=1.20 * $P_0$
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Demand drops by 20%: $Q_1$=$Q_0$×(1−0.20)=0.80* $Q_0$
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$E_1$=$P_1$×$Q_1$ i.e. (1.20* $P_0$)×(0.80 * $Q_1$)
or $E_1$=0.96×$E_0$
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Since the new expenditure ($E_1$) is 0.96 times the initial expenditure ($E_0$), the total expenditure has decreased by 4%.
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(1−0.96)×100=4% decline
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