Principles of Economics: Elasticity, Long-Run Average Cost, Productivity Growth, and Inflation

Running head: ECONOMICS 1
Principles of Economics
Name
Institution

ECONOMICS 2
Principles of Economics
Question 1 Solution
Elasticity is the percentage change of one economic variable to a change in the other variable,
which is closely related to it, such as demand, price, and income (Fouquet, 2014). Price elasticity
is, therefore, the responsiveness of quantity demanded to a change in price. As a result, if the
elasticity of demand is 1.4; consequently, it shows that the responsiveness of the quantitative of
drugs needed to the change of its price was found to be 1.4. Elasticity, which is greater than one,
is referred to as elastic i.e., the response of demand is greater compared to change in the prices of
the drugs (Gatwood et al., 2014). If the demand for the drug is elastic, then it shows that the
prices of the drugs will lead to a fall in the revenue, while a decrease in the total price leads to an
increase in revenue.
For the company to increase revenue, the price level should be favorable to the customers. As a
result, an elastic of 1.4 shows that the price level is higher than expected thus lowering the firm's
revenue earnings as shown in figure 1.0 below;

ECONOMICS 3
I would, therefore, advise the firm to lower the prices of its product since the output level will
increase to offset the decreased level of price. This is because most firms prefer to attain
marginal revenue, which can offset their daily operations than continue operating at a loss.
However, an elasticity of 0.6 is less than one, thus inelastic. As a result, I would advise the firm
to increase its prices to increase the revenue since there will be a decrease in units sold in the
market. As the volume of output decreases, the increase in marginal revenue will be used to
cover for the diminishing value in sales as the price increases, As a result, the firm will be able to
increase its price in order to be able to maximize the profit and with anticipation of future loss in
revenue to cover for the fixed costs.
Figure 2.0: Inelastic demand
From figure 2.0 above the increase in the price will increase the total revenue even if the total
output will decrease. This is because as the price increases with a decrease in sales, the income
collected will be stable in the long run, thus leading to a stable market revenue earnings
(Oliveira-Castro & Foxall, 2016).