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Consider the relationship between monopoly pricing and price elasticity of demand: (a) Explain why a monopolist will never produce a quantity at which the demand curve is inelastic. (Hint: If demand is inelastic and the firm raises its price, what happens to total revenue and total costs?) (b) Draw a diagram for a monopolist, precisely labeling the portion of the demand curve that is inelastic. (Hint: The answer is related to the marginal-revenue curve.) (c) On your diagram, show the quantity and price that maximizes total revenue.
SOLUTION 1 A monopolist always produces a quantity at which the demand curve is elastic. If the firm produced at a quantity for which the demand curve were inelastic, then if the firm raised its price, quantity would fall by a smaller percentage than the rise in price, so revenue would increase. Since costs would decrease at a lower quantity, the firm would have higher revenue…

and lower costs, so profit would be higher. Thus the firm should keep raising its price until profits are maximised, which must happen on an elastic portion of the demand curve. SOLUTION 2 SOLUTION 3 At E, Pm, Qm are the equilibrium price and quantity.



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