Arguing about economics late one night in your dorm room, your friend says, “In a free market economy, if people are willing to pay a lot for something, then businesses will charge a lot for it.” One way to translate your friend’s words into a model is to think of a product with highly inelastic demand: Items like life-saving drugs or basic food items. Let’s consider a market where costs are roughly constant: perhaps they rise a little or fall a little as the market grows, but not by much.
a. In the long run, is your friend right?
b. In the long run, what has the biggest effect on the price of a good that people really want: the location of the average cost curve or the location of the demand curve?