15.13 The price elasticity of demand for dental services is -0.25. In a market w
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Question
15.13 The price elasticity of demand for dental services is -0.25. In a market with 100 dentists, the local dental society demanded and received an 8 percent increase in prices from the dominant dental insurance company. What should happen to the dentists’ revenues and profits? (Assume that the average cost equal marginal cost equal marginal costs.) Would this agreement be stable? Explain.
15.14 The marginal cost of a physician visit is $40. In a county with 50 physicians, the local medical society negotiated a rate of $90. Previously, any physician who offered discounts to an insurer or a patient could be cited for unethical behavior, be expelled from the medical society, and lose admitting privileges to the county’s sole hospital. But having lost an antitrust lawsuit, the medical society has agreed to stop enforcing its prohibitions against discounting, to allow any physician with a valid license to be a member of the medical society, and to stop linking admitting privileges to medical society membership.
1. The price elasticity of demand for physicians’ services is -0.18. What price maximizes profits for the individual physicians in the county?
2. If all the physicians act independently, will their incomes go up or down?
3. Is there any way the physician could legally act to sustain price of $90 dollars?
Explanation / Answer
Answer 15.13-
Price Elacticity of demand = Percentage change in quantity demanded / Percentage change in price
-0.25 = x / 8
Thus, quantity demanded will decrease by .25 * 8 = 2 per cent.
Thus, fall in the quantity demanded will be less than the increase in the price level. Thus, the revenue of the dentists will rise and cost remaining the same, the profits will increase. Thus, when price elasticity of demand is inelastic, then any increase in prices will lead to increase in total revenue.
This agreement will be stable as long as the price elasticity of demand will remain inelastic. Due to factors like availability of substitutes, time period as in long run the price elasticity may rise, proportion of income spent on the good, if the PED increases, then Total Revenue will fall.
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