A firm will never operate _________ (above, below) the midpoint of a linear demand curve, where demand is ________ (elastic, inelastic). (Related to Application 3)

Transcribed Image Text:

Application 3 DRONES AND THE LOWER HALF OF A LINEAR DEMAND CURVE APPLYING THE CONCEPTS # 3: Will a firm choose a point on the lower half of a linear demand curve? Suppose a firm that produces hobby drones (for civilian use) has a linear demand curve for its product, with a vertical intercept of $800. The firm currently charges a price of $300. Do you have any advice for the firm? Your advice should be to increase the price. The price of $300 is certainly too low because it is less than the $400 price at the midpoint of the demand curve (half of $800). At a price of $300, the firm is below the midpoint of the demand curve, so the demand for its product is price inelastic. As a result, an increase in price from $300 to $400 would increases total rev- enue: the percentage decrease in quantity is less than the per- centage increase in price. The increase in price would decrease the quantity of drones demanded (the law of demand), so the firm would produce fewer drones at a lower total cost. Because an increase in price increases total revenue and decreases total cost, the firm's profit would increase. The same logic applies to any price below the midpoint price of $400. How much higher (how much above $400) should the price go? As we'll see later in the book, it depends on the cost of producing the product. Although we don't have the relevant cost information to pick the best price, we know for certain that it will be no less than $400 because a firm will never operate below the midpoint of a linear demand curve. Related to Exercises 3.5 and 3.9.