Question

The market demand curve for heroin is said to be highly inelastic. Heroin supply is also said to be monopolized by the Mafia, which we assume to be interested in maximizing profits. Are these two statements consistent?

Short answer

Yes, the statements are consistent; inelastic demand allows the Mafia to raise prices and maximize profits.

Step-by-step solution

Define Inelastic Demand

Inelastic demand occurs when the quantity demanded of a good or service is relatively insensitive to price changes. This means that even large changes in price lead to small changes in the quantity demanded. The elasticity coefficient for inelastic demand is less than 1.

Understand Profit Maximization

Profit maximization by a monopolist occurs where marginal cost (MC) equals marginal revenue (MR). In a market with inelastic demand, a monopolist can increase its price, leading to higher revenue because the drop in quantity demanded is proportionally smaller than the price increase.

Relate Inelastic Demand to Monopoly

A monopolist facing an inelastic demand curve would benefit from raising prices. Since the demand is inelastic, the increase in price will not significantly reduce the quantity sold, allowing the monopolist to increase total revenue and, potentially, profits.

Compare Statements for Consistency

The statements are consistent because the inelastic nature of heroin demand allows the Mafia, as a monopolist, to increase prices without a significant loss in sales volume, thereby maximizing profits.

Key concepts

Monopolist

A monopolist is a single seller or provider in a particular market, holding significant control over the supply of a product or service. Unlike competitive markets with many players, a monopolist faces no direct competition. This unique position allows the monopolist to dictate terms, such as price and production levels, largely unaffected by rivals' actions. In a monopolistic scenario, consumers lack alternative options, granting the monopolist significant pricing power. For heroin, assumed to be controlled by the Mafia, this monopolistic control suggests they can heavily influence market prices due to their dominance over supply. This capacity is intensified in markets with inelastic demand.

Profit Maximization

Profit maximization is the primary goal for any monopolist. The rule for achieving this is to equate marginal cost (MC) with marginal revenue (MR).
Marginal cost is the cost of producing one additional unit, whereas marginal revenue is the revenue earned from selling that extra unit.
In a market where demand is inelastic, a monopolist can raise prices without greatly affecting the quantity sold. Since inelastic demand means consumers will not significantly reduce their quantity demanded with a price increase, this strategy leads to increased revenues.

• Profit maximization point: where MC = MR.
• Inelastic demand allows for higher prices without much loss in quantity sold.

This is especially beneficial for a monopolist like the Mafia, selling heroin, because even if prices go up, the addicted consumers—or demand—may not decrease by much, ensuring sustained or amplified profits.

Elasticity Coefficient

The elasticity coefficient is a numerical measure that defines how sensitive the quantity demanded of a good is to a change in its price. If the elasticity coefficient is less than 1, the demand is considered inelastic, meaning consumers are less sensitive to price changes. For example, if the price of heroin increases, and the demand decreases only a little, it demonstrates inelasticity.

• The elasticity coefficient < 1 indicates inelastic demand.
• A low coefficient implies consumers' buying habits remain steady despite price changes.

For heroin, given its addictive nature, the elasticity coefficient is particularly low. This low elasticity allows a monopolist like the Mafia to increase prices without fearing a large drop in sales, thus consistently generating higher revenues. Understanding the elasticity coefficient helps explain why monopolists confidently adjust prices to maximize profits, especially in markets with inelastic demand where consumer behavior changes very slowly in response to price hikes.