You are the manager of a Mom and Pop store that can buy milk from a supplier at $2.00 per gallon.If you believe the elasticity of demand for milk by customers at your store is −3,then your profit-maximizing price is:
A) $1.33.
B) $2.75.
C) $3.00.
D) $4.50.

Question

Quizplus · Accepted Answer

Given the price elasticity of demand (PED) formula: PED = (% Change in Quantity Demanded) / (% Change in Price), and the rule for profit maximization under monopoly or monopolistic competition (Marginal Revenue = Marginal Cost), we can use the elasticity of demand to find the optimal price. The formula relating price elasticity of demand to optimal pricing is P = MC / (1 + (1/E)), where P is the optimal price, MC is the marginal cost, and E is the price elasticity of demand. Plugging in the values: $2.00 / (1 + 1/(-3)) = $2.00 / (1 - 1/3) = $2.00 / (2/3) = $3.00.

You Are the Manager of a Mom and Pop Store