Question

Suppose that a monopolist can segregate his buyers into two different groups to which he can charge two different prices. In order to maximize profit, the monopolist should charge a higher price to the group that has: \(L O 12.6.\) a. The higher elasticity of demand. b. The lower elasticity of demand. c. Richer members.

Short answer

Option b: The lower elasticity of demand.

Step-by-step solution

Understanding Elasticity

Elasticity of demand measures how much the quantity demanded of a good responds to a change in price. If demand is elastic, consumers will buy significantly more or less of the product when the price changes. If demand is inelastic, the change in quantity demanded is relatively small.

Profit Maximization Strategy

For a monopolist aiming to maximize profit, the optimal strategy is to charge different prices to different groups based on their demand elasticity. The group with the more inelastic demand (less sensitive to price changes) can be charged a higher price, while the group with more elastic demand should be charged a lower price.

Application of Elasticity Concept

In this exercise, the objective is to identify which group should be charged a higher price - the group with higher or lower elasticity. Since the group with a lower elasticity of demand is less sensitive to price changes, the monopolist can charge them a higher price without losing many sales.

Conclusion

Based on economic principles, the monopolist should charge a higher price to the group that has the lower elasticity of demand, as this maximizes profit by taking advantage of their lower price sensitivity.

Key concepts

Elasticity of Demand

Elasticity of demand is a key concept that helps us understand how sensitive consumers are to changes in price for a given good. Essentially, it measures the percentage change in quantity demanded that results from a one percent change in price. When we talk about elasticity:

• Elastic demand means that consumers are highly responsive to price changes. A small change in price leads to a large change in quantity demanded.
• Inelastic demand signifies that consumers are less responsive to price changes. Even if the price changes considerably, the demand does not significantly alter.

The elasticity of demand is crucial for businesses, especially for pricing strategies. Knowing whether a product has elastic or inelastic demand can determine how a company prices its products to maximize sales and profits. For instance, luxury goods usually have elastic demand, while essential goods often have inelastic demand.

Monopoly Pricing

Monopoly pricing occurs when a single company dominates the market for a specific product or service, allowing it to set the price. Unlike competitive markets where prices are driven by supply and demand, monopolies have the power to influence prices as per their strategies. Here is how monopoly pricing works:

• Monopolists aim to maximize profits by setting higher prices since consumers do not have alternative products to turn to.
• They might also employ price discrimination, charging different prices to different consumer groups based on their willingness to pay.

By leveraging their market power, monopolists can adjust prices to cater to various segments. For instance, they may charge more to consumers who have a lower elasticity of demand while offering discounts to those who demonstrate higher price sensitivity. This segmented pricing is strategic in extracting the maximum willingness to pay from each group.

Profit Maximization

Profit maximization is the primary goal for monopolists, achieved by setting prices in a way that the difference between total revenue and total cost is the greatest. Here is a breakdown of why and how this works:

• To achieve maximum profit, monopolists analyze the elasticity of different consumer groups. They set higher prices for groups with inelastic demand and lower prices for those with elastic demand to maximize revenue without losing sales volume.
• The total profit is calculated by subtracting the total cost from total revenue. The key is balancing price and quantity sold to gain the highest possible profit.

Monopolists exploit their market control to adjust pricing and maximize profit. By understanding the elasticity of demand, they strategically cater to different market segments to optimize their market power. Successful profit maximization involves a careful analysis of costs, demand elasticity, and market dynamics, ensuring that the highest possible marginal profit is achieved.