Suppose that the own-price elasticity of the market demand for TV is –0.4. If the (monopoly) seller raises the price a little bit, its profit will __ A. increase. B. decrease. C. increase or decrease, depending on other factors
The correct answer and explanation is:
Correct Answer: A. increase
Explanation:
The own-price elasticity of demand measures how much the quantity demanded of a good responds to a change in its price. In this case, the elasticity of demand for TVs is –0.4. This means that for a 1% increase in price, the quantity demanded decreases by only 0.4%. The demand is said to be inelastic because the absolute value of the elasticity (|–0.4| = 0.4) is less than 1.
When demand is inelastic, consumers are relatively unresponsive to changes in price. So, if a monopolist increases the price of TVs, the drop in quantity sold will be proportionally smaller than the increase in price. This results in an increase in total revenue. Since the cost of producing TVs generally remains the same or increases more slowly than revenue in the short run, profit will also increase.
A monopolist considers both marginal revenue and marginal cost when making pricing decisions. In the inelastic region of the demand curve, marginal revenue is positive, and raising prices leads to higher total revenue. As long as marginal cost does not increase sharply with output, profits rise with higher prices.
In competitive markets, firms are price takers and cannot raise prices without losing customers. However, a monopolist has pricing power and can influence the market price. In this scenario, the monopolist can exploit the inelastic demand to increase profits by raising prices.
In conclusion, because the demand is inelastic (|–0.4| < 1), a small increase in price will cause total revenue to rise and costs to stay relatively stable, leading to a higher profit. Therefore, the correct answer is A. increase.