Suppose a firm has market power and faces a downward sloping demand curve for its product, and its marginal cost curve is upward sloping. If the firm reduces its price, then:

A) consumer and producer surplus must increase.
B) consumer surplus increases, producer surplus may increase or decrease.
C) consumer surplus increases, producer surplus must decline.
D) consumer and producer surplus must decline.

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Shumailayousaf Yousaf · Accepted Answer

Final Answer : B, Explanation :  If the firm reduces its price, consumer surplus will increase as consumers will be able to purchase the product at a lower price. However, the change in producer surplus will depend on the elasticity of demand for the product. If demand is relatively elastic, then the increase in sales volume may offset the decrease in price, resulting in an increase in producer surplus. However, if demand is relatively inelastic, then the decrease in price may lead to a decrease in producer surplus. Therefore, the reduction in price may lead to an increase or decrease in producer surplus, while consumer surplus must increase.

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