Question

Suppose you work for a drug company that has discovered a vaccine for the common cold....

Suppose you work for a drug company that has discovered a vaccine for the common cold. Your company is the only producer of this vaccine, which means you have no competitors and you can set whatever price you wish. Let’s say you decide to charge $25 for each shot of the vaccine. One of the economists on your staff comes to you and reports that at that price the elasticity of demand for your vaccine is 1.6. A) Assuming you are a profit maximizing firm, would you want to change the price of the vaccine? Why or why not? B) How would your answer to part A change if your economist reported the elasticity of demand for your vaccine is 0.4? Why?  

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Answer #1

(A)

Since elasticity of demand is higher than 1, demand is elastic. With elastic demand, a decrease in price will increase quantity demanded more than proportionately, which will increase total revenue. So a price cut is better strategy.

(B)

Since elasticity of demand is less than 1, demand is inelastic. With inelastic demand, an increase in price will decrease quantity demanded less than proportionately, which will increase total revenue. So a price hike is better strategy.

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