Monopoly price and its relationship to elasticity of demand.
The total revenue test can be applied for explaining the monopoly price and its relationship to price elasticity of demand. The total revenue test tells us that when demand is elastic, a decline in price will increase total revenue. When demand is inelastic, a decline in price of a good will decrease its revenue Applying this test, a monopolist will fix the amount of his product at a level where the elasticity of his average revenue curve is greater than one (E > 1). It causes total revenue to increase. Here marginal revenue is positive. A monopolist does not push his produce to the point where the margin:741‘–cvenue becomes negative.The monopolist choice of price when faced with varying degree of elasticities is now o explained with the help of a linear average revenue function (price line) in fig 16.2.
At midpoint which is P on the down sloping AR curve, elasticity of demand is equal to one = E = 1 MR is zero. The total revenue of the firm is at its maximum, neither increasing nor
- ·decreasing. On the. other hand when the demand is inelastic (Ep < 1), the marginal revenue is negative. The total revenue decreases with the decrease in pace.
When price is above midpoint P, marginal revenue of the firm is positive. So the total revenue increases as the price falls. Tha monopolist will set the price of the good at which the elasticity is equal to one is point P at the rriid •point on the demand curve Ordinarily the profits of the monopolist are maximum where his MR 7 MC and the point of equilibrium on the AR curve will be that at which elasticity of demand is greater than one..
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