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Suppose the number of firms you compete with has recently increased. You estimated that as a...

Suppose the number of firms you compete with has recently increased. You estimated that as a result of the increased competition, the demand elasticity has increased from –2 to –3, i.e., you face more elastic demand. You are currently charging $10 for your product. What is the price that you should charge, if demand elasticity is -3?

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Answer #1

As a result of the increased competition, the demand elasticity has increased from –2 to –3. You are currently charging $10 for your product. What is the price that you should charge, if demand elasticity is -3?

Let the marginal cost be MC. Optimum rule suggests that

P1 = MC*(E1/E1 + 1) and P2 = (E2/E2 + 1)

10 = MC*(-2/-1) and P2 = MC*(-3/-2)

MC = $5 and so P2 = 5*1.5 = $7.5

This implies that the price that you should charge, if demand elasticity is -3 is $7.5 per unit.

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