Question

Ford Motors has determined that the price elasticity of demand for two customer segments (A Luxury Car’s price elasticity of demand is -1.25 while a Premium Car’s price elasticity of demand is -1.65. Based on their expectations of profitability, Ford realizes the price of a Luxury Car should be $71,500. How much should Ford charge for its Premium Car?

Answer 1

Ford finds the price for Luxury cars according to the rule: MR = MC
where MR = P[1 - (1/e)]
P = 71,500; e = 1.25
So, MR = 71,500*[1 - (1/1.25)] = 71,500*[(1.25 - 1)/1.25] = 71,500*(0.25/1.25) = 14,300
So, MR = MC give MC = 14,300

Now, Ford determines the price for Premium car according to the rule MR = MC = 14,300
Where MR = P[1 - (1/e)] and e = 1.65

So, MR = MC = 14,300 gives,
P[1 - (1/1.65)] = 14,300
So, P[(1.65 - 1)/1.65] = 14,300
So, P(0.65/1.65) = 14,300
So, P = 14,300(1.65/0.65)
So, P = 36,300

Thus, Ford charge $36,300 for its Premium Car.