IAI Actuarial Core Principles · Business Economics · Impact of advertising on sales and demand
A mutual fund company with monopoly power sets price where marginal revenue equals marginal cost. Its advertising raises the quantity demanded at every price, and its average revenue elasticity at the profit-maximising price is 4 in absolute value. Its marginal cost is ₹30 per unit of service. What is the profit-maximising price using the mark-up rule P = MC / (1 − 1/|e|)?
The price is ₹40. With elasticity of 4, marginal revenue equals 0.75 times price, and setting that equal to marginal cost of ₹30 gives price of 30 divided by 0.75, which is ₹40.
- A₹30.00
- B₹37.50
- C₹40.00Correct
- D₹120.00
- ₹32.50
Explanation
MR = P(1 − 1/4) = 0.75P. Setting MR = MC gives 0.75P = 30, so P = 40. Check: MR = 0.75 × 40 = 30. ₹37.50 would come from dividing by 0.8, a wrong elasticity, and ₹120 from multiplying by 4.
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