Suppose the market demand curve has an elasticity of - 4. If the monopolist's average cost is a horizontal straight line, then the profit is:
A)half the total revenue.
B)one quarter of total revenue.
C)not related to the total revenue.
D)equal to the total revenue.

Question

Quizplus · Accepted Answer

When the demand elasticity is -4, the monopolist can increase their price by 1% and the quantity demanded would decrease by 4%. If the average cost is a horizontal straight line, the monopolist would produce where marginal revenue equals average cost. Since the demand is elastic, the marginal revenue curve will be below the demand curve. Therefore, the price will be greater than the average cost, and the monopolist will make a positive profit. The profit-maximizing quantity will be where marginal revenue equals marginal cost. Given that the average cost is constant, this is where average revenue equals average cost as well. Using the midpoint method, the price elasticity of demand at the profit-maximizing quantity will be -2. Therefore, the markup over marginal cost will be 1/3. The profit per unit sold will be (1/3)(price - average cost). The profit will be maximized when the output is the point that satisfies marginal revenue = marginal cost. Therefore, profit will be one-quarter of total revenue.

Suppose the Market Demand Curve Has an Elasticity of -