Question

Suppose there are two types of razor blade customers. Group A views Gillette razor blades as almost a commodity and has a price elasticity of demand equal to 11. Group B views Gillette razor blades as something special and values Gillette’s added features. They have a price elasticity of demand equal to 1.5. Commodity type razor blades can be produced at MC= 1. Special razor blades can be produced at MC= 2. What price should Gillette charge for each type of razor blade assuming their goal is to maximize profit? Write a few sentences to explain the scenario.

Answer 1

Given the elasticity of both commodity type razor blades and special razor blades produced by Gillette, the Lerner's index is given by the formula:

(P - MC)/P = 1/e, where P = price, MC = marginal cost and e is in absolute terms.

Commodity type razor blades:

Using the Lerner index formula to find for P,

1-MC/P = 1/e

1-1/P = 1/11 which gives P = 1.10$

Special razor blades:

1-MC/P = 1/e

1-2/P = 1/1.50 which gives P = $6

Thus, Gillette shoukd charge $ 1.10 for its commodity type razor blade and $6 for its special type razor blade. The vast difference in prices arise due to difference in elaticity of demand. The greater the elasticity of the commodity, the lower the price.