Under which of the following conditions would a profit-maximizing monopolist necessarily raise price?
A) if product demand was price-elastic
B) if product demand was price-inelastic
C) if marginal revenue was greater than marginal cost
D) if marginal cost was greater than marginal revenue
The correct answer and explanation is :
The correct answer is B) if product demand was price-inelastic.
Explanation:
A profit-maximizing monopolist adjusts the price of its product based on the elasticity of demand and the relationship between marginal revenue (MR) and marginal cost (MC).
- Price Inelasticity of Demand (Option B):
- In the context of a monopoly, the demand curve typically slopes downward, meaning that price and quantity demanded are inversely related. If the product’s demand is price-inelastic, it means that the percentage change in quantity demanded is smaller than the percentage change in price (i.e., consumers’ demand does not decrease significantly with higher prices).
- When demand is inelastic, the monopolist can raise prices without losing a significant amount of customers. This increase in price leads to higher total revenue because the decrease in quantity demanded is proportionally smaller than the increase in price.
- Since marginal revenue is still positive and greater than marginal cost (as the firm can still increase profits by charging a higher price), the monopolist would be incentivized to raise the price to maximize profits.
- Price Elasticity of Demand (Option A):
- If the product demand were price-elastic, raising the price would lead to a proportionally larger decrease in quantity demanded, which would reduce total revenue. In this case, a profit-maximizing monopolist would reduce the price, not raise it, to maximize revenue.
- Marginal Revenue Greater Than Marginal Cost (Option C):
- If marginal revenue (MR) is greater than marginal cost (MC), the monopolist could increase production to maximize profit, but this condition alone doesn’t necessarily imply that the monopolist would raise the price. Rather, the monopolist would continue increasing output as long as MR > MC to maximize profit. If demand is elastic, it might even lower the price to increase sales.
- Marginal Cost Greater Than Marginal Revenue (Option D):
- If marginal cost (MC) exceeds marginal revenue (MR), the monopolist is producing more than is optimal and would reduce output and potentially lower the price to return to a profit-maximizing level.
In summary, a monopolist will raise the price if the demand is price-inelastic because the firm can increase total revenue by charging a higher price, while the reduction in quantity demanded will be small enough that the monopolist still benefits.