Question

Statement L. A perfectly elastic demand curve has an elasticity of zero. Statement II. When demand is elastic and price is raised, total revenue will fall. (LOl) a) Statement I is truc, and statement II is false. b) Statcment II is true, and statement I is false. c) Both statements are true. d) Roth statements are false.

Short answer

has an elasticity of zero. This statement is incorrect because an elasticity of zero corresponds to a perfectly inelastic demand curve, not a perfectly elastic demand curve. #tag_title# Analyze Statement II#tag_content# Statement II states that when demand is elastic and price is raised, total revenue will fall. This statement is correct because, in elastic demand situations, the percentage change in quantity demanded is greater than the percentage change in price. Therefore, when price increases, total revenue will decrease. #tag_title# Select the Correct Answer Choice#tag_content# Since Statement I is false and Statement II is true, the correct answer choice is: b) Statement II is true, and statement I is false.

Step-by-step solution

Understand Perfectly Elastic Demand and Elasticity

A perfectly elastic demand curve is a horizontal line where demand is infinite at a specific price level. In this situation, a small change in price will result in an infinite increase or decrease in the quantity demanded. Demand elasticity measures the responsiveness of quantity demanded to a change in price. A demand elasticity equal to zero indicates a perfectly inelastic demand curve (i.e., the quantity demanded will not change in response to any price change).

Analyze Statement I

Statement I states that a perfectly elastic demand curve

Key concepts

Demand Elasticity

Understanding demand elasticity is crucial when we delve into the dynamics of market economics. It refers to how sensitive the quantity demanded of a good or service is to a change in its price. In the realm of economics, this sensitivity is quantified as the percentage change in quantity demanded in response to a one percent change in price.

Picture walking into a store where your favorite candy's price has increased significantly. If this change leads you to buy less candy or switch to another brand, your response indicates a high elasticity for that candy. Conversely, if you shrug off the price rise and purchase the same amount as before, your demand would be considered inelastic.

Factors Influencing Demand Elasticity

Several factors can affect demand elasticity, such as:

• The availability of substitutes: The more easily a product can be replaced, the higher its elasticity.
• The proportion of income spent on the good: More expensive goods tend to have more elastic demand.
• Time frame: Demand often becomes more elastic over time as consumers find alternatives.

So, when discussing a perfectly elastic demand, we are talking about a scenario where consumers have infinite flexibility, and even the slightest price increase drives the quantity demanded to zero — a situation more theoretical than practical in the real world.

Total Revenue

Moving on to total revenue, it is a core financial metric used primarily by businesses to understand the effectiveness of their pricing strategy. It's calculated simply by multiplying the price of a good by the quantity sold. When businesses map out price changes, they need to carefully consider how these changes will affect their total revenue.

For example, if a company increases the price of its product and finds that sales volume remains unchanged, total revenue increases. However, if the demand is elastic to the point where consumers are extremely price-sensitive, a price hike might lead to a significant drop in the quantity sold, which could reduce total revenue. It's a delicate balance that firms must strike, considering the elasticity of their products.

Price Changes and Revenue

In the context where demand is perfectly inelastic — for instance, life-saving medicine — an increase in price does not change the quantity demanded, and therefore the total revenue rises. Nonetheless, with perfectly elastic demand, any attempt to raise prices could result in a dramatic drop to zero in quantity demanded, thus reducing total revenue to nothing. It is essential for businesses to know where their products stand in terms of demand elasticity to forecast the implications of price adjustments on their total revenue.

Price Elasticity of Demand

Lastly, let's dive deeper into price elasticity of demand. This is a specific measure of demand elasticity that reflects the extent to which the quantity demanded of a good responds to a change in its price. It's a numeric value: if the absolute value of the figure is greater than one, the demand is considered elastic; if it is less than one, the demand is inelastic.

Returning to the original exercise, the first statement incorrectly suggests that a perfectly elastic demand curve has an elasticity of zero, which is not true. In fact, a perfectly elastic demand curve will have an elasticity of infinity because any increase in price will cause the quantity demanded to drop to zero instantaneously – consumers will stop buying immediately. The correct answer to the exercise is that statement I is false, and statement II is true: when demand is elastic and the price is raised, total revenue will indeed fall.

Applying Price Elasticity

It is the concept of price elasticity of demand that businesses and economists use to predict consumer behavior and strategize accordingly. For instance, luxury car manufacturers operate under the assumption that their customers have a less elastic demand curve, allowing them to charge premium prices. At the other end of the spectrum, sellers of staple goods might face a highly elastic demand, ensuring their pricing strategy aims for volume sales rather than high margins per unit.

Understanding the nuances of price elasticity helps businesses and policymakers make informed decisions that align with consumer sensitivity to price changes.