Economics Monopoly Price Relationship to Demand Elasticity Discussion
ANSWER
Elasticity is a measure of how sensitive the quantity demanded or supplied of a good is to a change in price. There are three categories of elasticity: elastic, unitary, and inelastic.
- Elastic demand: When the percentage change in quantity demanded is greater than the percentage change in price (elasticity > 1).
- Unitary demand: When the percentage change in quantity demanded is equal to the percentage change in price (elasticity = 1).
- Inelastic demand: When the percentage change in quantity demanded is less than the percentage change in price (elasticity < 1).
Now, let’s consider the marginal revenue curve of a monopolist. The marginal revenue (MR) is the additional revenue earned from selling one more unit of a good. For a perfectly competitive market, the marginal revenue is equal to the price because firms can sell any quantity at that price. However, for a monopolist, to sell one more unit, they need to lower the price for all units, which means that marginal revenue is not equal to the price.
Here’s the crucial part: the monopolist can only sell more if the marginal revenue is positive, because if MR is negative, the decrease in price outweighs the increase in quantity sold, leading to reduced total revenue.
When the monopolist sets a price, they essentially move along the demand curve. If demand is elastic, a decrease in price will lead to a proportionally larger increase in quantity demanded. Since marginal revenue is positive within the elastic range, the monopolist can increase revenue by producing and selling more units.
If demand is unitary elastic, a change in price will result in an equal percentage change in quantity demanded. In this case, the monopolist can still increase revenue by producing more units, but the percentage increase in quantity is exactly matched by the percentage decrease in price.
If demand is inelastic, a decrease in price will lead to a proportionally smaller increase in quantity demanded. Here’s where the hint you mentioned comes into play. If marginal revenue becomes negative at low prices, it means that the monopolist can’t profitably operate in that range. This negative MR indicates that the demand is inelastic in that range and the monopolist would operate on the elastic portion of the demand curve instead.
Example: Let’s say a monopolist is selling widgets and wants to maximize their revenue. If they observe that the demand for widgets is highly elastic at a particular price, they could consider lowering the price to increase their total revenue, as the increase in quantity demanded will more than compensate for the decrease in price. On the other hand, if they find that the demand is inelastic at a certain higher price, they might refrain from raising the price further, as any decrease in quantity demanded due to the higher price might not be offset by the price increase.
Remember, the monopolist’s goal is to find the price and quantity combination that maximizes their profit, and understanding elasticity helps them make informed decisions about their pricing strategy.
- Elastic demand: When the percentage change in quantity demanded is greater than the percentage change in price (elasticity > 1).
- Unitary demand: When the percentage change in quantity demanded is equal to the percentage change in price (elasticity = 1).
- Inelastic demand: When the percentage change in quantity demanded is less than the percentage change in price (elasticity < 1).
Now, let’s consider the marginal revenue curve of a monopolist. The marginal revenue (MR) is the additional revenue earned from selling one more unit of a good. For a perfectly competitive market, the marginal revenue is equal to the price because firms can sell any quantity at that price. However, for a monopolist, to sell one more unit, they need to lower the price for all units, which means that marginal revenue is not equal to the price.
Here’s the crucial part: the monopolist can only sell more if the marginal revenue is positive, because if MR is negative, the decrease in price outweighs the increase in quantity sold, leading to reduced total revenue.
When the monopolist sets a price, they essentially move along the demand curve. If demand is elastic, a decrease in price will lead to a proportionally larger increase in quantity demanded. Since marginal revenue is positive within the elastic range, the monopolist can increase revenue by producing and selling more units.
If demand is unitary elastic, a change in price will result in an equal percentage change in quantity demanded. In this case, the monopolist can still increase revenue by producing more units, but the percentage increase in quantity is exactly matched by the percentage decrease in price.
If demand is inelastic, a decrease in price will lead to a proportionally smaller increase in quantity demanded. Here’s where the hint you mentioned comes into play. If marginal revenue becomes negative at low prices, it means that the monopolist can’t profitably operate in that range. This negative MR indicates that the demand is inelastic in that range and the monopolist would operate on the elastic portion of the demand curve instead.
Example: Let’s say a monopolist is selling widgets and wants to maximize their revenue. If they observe that the demand for widgets is highly elastic at a particular price, they could consider lowering the price to increase their total revenue, as the increase in quantity demanded will more than compensate for the decrease in price. On the other hand, if they find that the demand is inelastic at a certain higher price, they might refrain from raising the price further, as any decrease in quantity demanded due to the higher price might not be offset by the price increase.
Remember, the monopolist’s goal is to find the price and quantity combination that maximizes their profit, and understanding elasticity helps them make informed decisions about their pricing strategy.
Question Description
I’m trying to study for my Economics course and I need some help to understand this question.
Recalling what you have learned about elasticity, what can you say about the connection between the price a monopolist chooses to charge and whether or not demand is elastic, unitary, or inelastic at that price? (Hint: Examine the marginal revenue curve of a monopolist. The fact that marginal revenue becomes negative at low prices implies that a portion of the demand curve cannot possibly be chosen.) Please include an example with your posting.
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