Question from Past Microeconomics Qualifying ExamEdit
Spring 2005 - Section I, Question one, George Mason University
T,F,U. State first whether the following statements are true, false or uncertain. Then briefly explain your resaoning in four or five sentences. You may sue a graph if it helps clairify your answer.
A monopolist always prefers to produce in the inelastic portion of the demand curve, if possible, because that's where consumers are least responsive to changes in price.
False, the monopolists output decision is independent of price elasticity.
Price elasticity changes along a linear demand curve from 0 at the intersection with the horizontal axis to infinity at the intersection with the vertical axis. Where a ray from the origin and the demand curve form a right angle, demand is unit elastic, i.e. 1.
"When demand is elastic, lower price is associated with higher revenue. The reverse holds when demand is inelastic. So for levels of output at which demand is elastic, increased output leads to leads to lower price but nevertheless to increased revenue for the firm: Marginal revenue is positive. And similarly, when demand is inelastic, Marginal Revenue is negative. But since Marginal cost is never negative, and since Marginal Cost must equal Marginal Revenue at the monopolist's price-quantity optimum, the monopolist will never produce in the region of inelastic demand." (Hirshleifer, "Price theory and applications", seventh edition, P. 225)