Refer to the following figure:

The figure above shows the demand and cost curves facing a price-setting firm.
-In profit-maximizing (or loss-minimizing) equilibrium, the Lerner index is _____, and the elasticity of demand is ______.

Question

Refer to the following figure:
  
The figure above shows the demand and cost curves facing a price-setting firm.
-In profit-maximizing (or loss-minimizing) equilibrium, the Lerner index is _____, and the elasticity of demand is ______.

Quizplus · Accepted Answer

The Lerner index is calculated as (P-MC) / P, where P is the price and MC is the marginal cost. In the diagram, we can see that the distance between point E and point C is equal to the price (P), while the distance between point C and the intersection of MC and demand curve is equal to the marginal cost. Therefore, the Lerner index is (F1F1F1E1-F1F1F1C1) / F1F1F1E1 = (20-8) / 20 = 0.6.

The elasticity of demand at the profit-maximizing output level can be determined by drawing a tangent line to the demand curve at point E, which is the point where MR=MC. The slope of this line represents the elasticity of demand. In the figure, the elasticity is approximately equal to (F1F1F1S1-F1F1F104) / F1F1F1E1 = (32-16) / 20 = 0.8. However, since the question asks for the elasticity at the profit-maximizing output level, we need to draw a horizontal line from point E to the y-axis (i.e. set MR=0), which intersects the demand curve at point F. The elasticity at point E is then equal to (F1F1F1S1-F1F1F1F) / F1F1F1E1 = (32-20) / 20 = 0.6.

Refer to the Following Figure