Question

a monopolist firm faces a demand with constant elasticity of -2.0. it has a constant marginal cost of $20 per unit and sets a price to maximize profit. if marginal cost should increase by 25%, would the price charged also rise by 25%?

Answer 1

The monopolist’s pricing rule is:

$\frac{P - MC}{P} = - \frac{1}{E_d}$

Or alternatively

$P = {MC/ (1+\frac{1}{E_d} )$

Price should be set so that P = MC / { 1+(1 / 2)}

As a result of this, the value will be -2MC.

With Marginal Cost of $20, the optimal price will be:

P = -2 (20) = -40.

When there is an increase in Marginal Cost by 25% to 25, and the new optimal price will be:

P = -2 (25) = -50

That is a 25% decrease.  

A 2.0 constant elasticity of demand is presented to a monopolist corporation. It establishes a price to maximise profit while maintaining a constant marginal cost of $20 per unit.

Thus, when there is an increase of marginal cost by 25%, the price will decrease by 25%.

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