Question

List and explain the factors that influence price elasticity of demand. What will make demand more or less elastic?

Explain the relationship between price elasticity and total revenue.

Define and explain how marginal, total and average values are related in general and specifically for utility, product, cost, revenue and profit.

Explain why diminishing marginal utility is related to the Law of Demand.

Explain the difference between economic and accounting profit.

Explain why increasing MC is related to the Law of Supply.

Explain how differences in market structure (perfect competition, monopoly, monopolistic competition and oligopoly) affects how a firm perceives the demand curve and marginal revenue, and thus profit maximizing output and overall efficiency (price relative to marginal cost).

Explain how barriers to entry and long term price and profitability (P-AC) are related, and how that might impact antitrust and regulatory policy.

Answer 1

1. Factors that affect price elasticity of demand

• Large number of substitutes: when a number of substitutes are available then the good or service tends to be more elastic. When number of substitute available is less then elasticity of demand is low.
• Time duration: Longer the time duration higher the elasticity of demand. In short run price elasticity of demand tends to be small. While in the long run the elasticity is high. As in the long run more number of substitute would be available.
• Percent of budget: when we are talking about costly goods then it consumes a larger chunk of our budget then the elasticity tends to be high. While in case of less costly good or service as it consumes a small portion of our income therefore it is less elastic.

2. When price elasticity of demand is unitary that is E = 1. Then the total revenue is maximum.

In case of price elastic demand higher the price lower the total revenue and lower the price higher the revenue. Therefore, in case of price elastic demand one must not increase the price as it will reduce the total revenue.

Price inelastic demand higher the price higher the total revenue and lower the price lower the total revenue. Thus, in case of price inelastic demand we must increase the price in order to increase total revenue.

3. Marginal product /cost /utility is defined as the change in total quantity /cost /utility with the change in additional unit of input.

When marginal product of labour is maximum then the marginal cost per unit is minimum. When average product is maximum then it is equal to marginal product and the Average cost is minimum and equal to marginal cost.

4. According to Law of Demand higher the price lower the demand and lower the price higher the demand.

In case of diminishing marginal utility it is stated that with the consumption of every additional unit the utility derived through consumption decreases. Therefore the Marginal Utility curve is a negative downward sloping curve similar to a demand curve.

5. In case of accounting profit only explicit cost is considered.

Accounting profit = Revenue - Explicit cost

In case of economic profit we consider the explicit as well as implicit cost. Therefore, economic profit is measured using the following formula

Economic profit = Revenue -Explicit cost -Implicit cost.

6. Supply curve is a upward sloping positive linear curve. This means with the increase in price of the goods or services the quantity supplied too increases. Similarly the Increasing MC curve is upward sloping and increases with the increase in quantity therefore, it is considered as supply curve.

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