Question

Suppose there is one firm in a market with linear demand function. The firm has a constant marginal cost of $9. The firm is currently charging $15 per unit, where the elasticity of demand is 3. The new CEO of this firm suspects that the current pricing strategy of this firm might not be profit maximizing. He hires you as an economic consultant to offer advice to this firm. Base on the information given, is the firm currently maximizing profits (choosing a monopoly price and quantity)? If not, should the firm raise its price or lower its price? Explain.

Answer 1

We employ the fact that Pprofit Maximizing Price = Marginal cost * (ed/ed + 1)

Price = $9 * (-3 / (-3 + 1))

Price = $9 * (-3/-2)

Price = $9 * 1.5

Price = $13.5

As we can see that the profit maximizing price is 13.5. Whereas, the current price of $15 which is not profit maximizing. So the firm should reduce the price to 13.5 per unit so as to be maximizing profit.