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IAI Actuarial Core Principles · Business Economics · Production, costs, revenue and profit in price and output decisions

A firm with market power sells in two separable markets and can price discriminate. Market A has price elasticity of demand of -2 and Market B has -4 (absolute values 2 and 4). Marginal cost is the same in both. Compared with Market B, the profit-maximising price in Market A will be:

Market A's price will be higher. With equal marginal cost, the profit-maximising price is MC divided by (1 - 1/elasticity), giving 2 times MC at elasticity 2 and about 1.33 times MC at elasticity 4, so the less elastic market bears the higher price.

  1. ALower, because demand is more elastic
  2. BHigher, because demand is less elasticCorrect
  3. CThe same, because marginal cost is equal
  4. DLower, because marginal revenue is higher
  5. Indeterminate without knowing quantities

Explanation

MR = P(1 - 1/e). Setting MR = MC gives P = MC/(1 - 1/e). With e = 2, P = 2MC; with e = 4, P = 1.33MC. So the less elastic market A has the higher price. Equal marginal cost does not imply equal prices once MR differs across markets.

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