Question

You are the manager of a Mom and Pop store that can buy milk from a supplier at $3.00 per gallon. If you believe the elasticity of demand for milk by customers at your store is -2, then your profit-maximizing price is:

Answer 1

To maximize profits, the manager of a store should set the milk price at $4.50 per gallon, accounting for a 50% mark-up based on the given elasticity of demand for milk, which is -2.

Step-by-step explanation:

The question relates to finding the profit-maximizing price for milk in a Mom and Pop store, given an elasticity of demand and cost per gallon. The elasticity of demand for milk is indicated as -2, which is a measure of how demand varies with price. In this scenario, for profit maximization, the store manager should use the formula for mark-up pricing, which is given by:

Mark-up = -1 / (Elasticity of demand)

Using the elasticity value of -2:

Mark-up = -1 / (-2) = 0.5

The mark-up here is 50% over the cost of the milk. Since the cost price is $3.00 per gallon:

Profit-maximizing price = Cost Price * (1 + Mark-up)

Profit-maximizing price = $3.00 * (1 + 0.5)

Profit-maximizing price = $3.00 * 1.5

Profit-maximizing price = $4.50 per gallon

This calculation assumes ceteris paribus, which means all other factors remain constant. By setting the price at $4.50 per gallon, the store would be setting a price that is expected to maximize profits given the known elasticity of demand for milk.