posted by Marie on .
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.