Suppose that at a monopolist's current output the elasticity of demand is -0.40. What should the...

Question:

Suppose that at a monopolist's current output the elasticity of demand is -0.40. What should the monopolist do to raise profits?

Total Revenues and The Price Elasticity of Demand:

Total revenues is the income that a firm receives from selling a given amount of its output. It is calculated by multiplying the total output sold by the selling price. The price elasticity of demand measures the responsiveness of the quantity demanded of a good or service when the price of the product changes. The concept of elasticity of demand is important in determining what a firm should do to increase revenues if the demand for its product is elastic or inelastic.

Answer and Explanation: 1

Since the demand for its product is inelastic, the monopolist should increase the price of its product in order to increase profits.

The relationship between the price elasticity of demand and the total revenues is given by:

{eq}\Delta TR = Q( 1 - e_d)\Delta P {/eq}

Where:

  • {eq}\Delta TR {/eq} is the change in total revenues,
  • {eq}e_d {/eq} is the price elasticity of demand and'
  • {eq}\Delta P {/eq} is the change in price.

When the demand is elastic, that is, when {eq}e_d>1 {/eq}, the price and the total revenues move in the opposite direction. An increase in price would reduce the total revenues.

When the demand is inelastic, that is, when {eq}e_d<1 {/eq}, the price and the total revenues move in the same direction. An increase in price would increase the total revenues and a decrease in price would decrease the total revenues.


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Price Elasticity of Demand in Microeconomics

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Chapter 2 / Lesson 11
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In microeconomics, the principle of price elasticity of demand is important to understand. Learn the definition of price elasticity of demand, understand the formula and its categories, and see some calculation examples.


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