Suppose a manufacturer estimates its marginal cost at $1.00 per pack, it's own price elasticity at -2, and sets its price at $2.The company's settlement obligations are expected to raise its average total cost per pack by pack by about $.60.

What effect will this have on its optimal price?

Can you direct me in a direction?

Lets start with the assumption that the firm, prior to the settlement, was operating at a profit-maximizing level; where Marginal Costs=Marginal Revenues. From the information, the firm must have some monopoly power. it sets a price above MC, and is operating in an elastic portion of the demand curve.

Then, along comes a "settlement obligation"

Now then, in order to answer, "what happens", we need to know a little more about the company's "settlement obligations" In particular, are the settlement obligations fixed costs or variable costs?

If the settlement raises fixed costs, then the company does nothing. Marginal costs do not change, and there is nothing to suggest that demand changes, ergo marginal revenue doesn't change.

If the settlement raises variable costs, then margianl costs will also rise. (You are not given enough information to say by how much marginal costs rise. Only that average total costs rise by $.60.)

Most likely, the firm will raise prices which in turn raises marginal revenues. Again, we do not have enough information to state the dollar increase in prices.

I hope this helps.

Yes, you gave me a good direction to head in. Again, thanks.

To determine the effect on the optimal price, we need to consider the impact of the settlement obligations on the cost structure of the company.

The average total cost (ATC) per pack is expected to increase by $0.60 due to the settlement obligations.

Since the marginal cost (MC) is estimated at $1.00 per pack, we can calculate the new marginal cost as:
New MC = MC + increase in cost = $1.00 + $0.60 = $1.60

To calculate the new price, we need to use the price elasticity of demand. The price elasticity of -2 means that a 1% increase in price will result in a 2% decrease in demand.

To maintain the same revenue level, the company needs to adjust the price by the same percentage change in demand. Since the demand is expected to decrease by 2% with a 1% increase in price, we can calculate the percentage change in price as:
Percentage change in price = (Percentage change in demand) / (Price elasticity of demand) = 1 / (-2) = -0.5

Now, let's calculate the new price:
New price = Old price * (1 + Percentage change in price) = $2 * (1 - 0.5) = $2 * 0.5 = $1

Therefore, the optimal price for the company considering the increase in average total cost is $1 per pack.

As for the direction, you might want to further explore the impact of changes in cost and elasticity on pricing decisions.

To determine the effect on the optimal price, we need to consider the changes in both marginal cost and average total cost. Here's how you can approach this:

1. Start with the initial situation:
- Marginal cost per pack (MC) = $1.00
- Price elasticity of demand (PED) = -2
- Price (P) = $2.00

2. Calculate the initial profit per pack:
Profit per pack = P - MC
= $2.00 - $1.00
= $1.00

3. Consider the impact of the expected increase in average total cost (ATC) by $0.60 per pack.
- New ATC per pack = Initial ATC per pack + Expected increase in ATC per pack
= Initial ATC per pack + $0.60

4. Determine the new marginal cost after considering the expected increase in average total cost.
- New MC per pack = ATC per pack + (Expected increase in ATC per pack ÷ Quantity produced)
= New ATC per pack + ($0.60 ÷ Quantity produced)

5. Calculate the new optimal price:
New Profit per pack = P - New MC per pack

Since price elasticity of demand (PED) is constant, we can use the following formula to find the new optimal price:
New Profit per pack / New PED = New P - New MC per pack

Rearranging the formula, we get:
New P = New Profit per pack / New PED + New MC per pack

Now that you have the framework, you can substitute the specific values into the formulas to calculate the new optimal price.