Question

You have been hired to advise a monopolist on its pricing and output policy. An independent research firm has estimated its elasticity of demand to be –0.5. Would you recommend that the monopolist change its output? If so, in what direction? Explain your answer and illustrate with an appropriate graph.

Answer 1

When price elasticity is less than unit elastic means there is a scope of monopoly power over market price because as it is known perfect competition exists at perfect price elasticity where all firms take the price as given so to practice some influence over price, firms require having inelastic demand. If it is given that price elasticity of demand is 0.5 implies for 100% change in price, quantity demanded changes by 50%. A monopolist would raise the price accordingly even if it requires to less a lower than efficient output practicing its monopoly power.