Question

Assume two firms exist in the market, Buckley and Stetler. If they merge, they will have fixed costs of $140,000, marginal costs of $50, and a market share of 6 percent. The price elasticity of demand for clinic services is -0.22. Assume the volume of patients at the profit-maximizing price is 24,600. The merged firm's estimated price elasticity of demand is

Select one:

a. -3.667

b. -0.3667

c. -36.667

d. -6

Urgently
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Answer 1

We know that the price elastictity of demand for a smaller firm is more than the overall market elasticity of demand or demand elasticity of larger players in the market. This is mainly due to cross elasticities of demand.

For equal sized firms in terms of market share (under Cournot Competition assumption),

Ed = nED,

where, Ed is firm's price elasticity of demand; ED is the price elasticity of demand for the market as a whole; & n= number of equal sized firms in the market.

Assuming that there are same sized firms in the market as the newly merged firm, that means, each firm's market share is 6%. This implies that no. of firms (n) = 100/6%.

=> Price elasticity of demand for merged entity (Buckley +Stetler) = 100/6% X (-)0.22 = (-)3.667.

Therefore alternative a) is correct.