The fully allocated cost of a product is $10. If the price elasticity of demand for the product is -2, then the firm's optimal markup is
A) 10 percent.
B) 100 percent.
C) 200 percent.
D) None of the above is correct.

Question

Quizplus · Accepted Answer

The optimal markup formula is given by $Markup = \frac{1}{|E_d|}$, where $E_d$ is the price elasticity of demand. Given $E_d = -2$, the optimal markup is $1/2 = 0.5$ or 50%. However, since the cost is $10, a 50% markup means charging $15 (a $5 increase on the $10 cost), which is indeed a 50% increase on the cost, but in terms of the final price over cost, it's a 100% markup. Therefore, the correct answer is 100 percent.

The Fully Allocated Cost of a Product Is $10