Question #2002475: Elasticity Theory


Question: Suppose that ELM Corporation sells two products, A and B. Suppose further that ?A = -1.5 and ?B = -2, where ?i denotes the own-price elasticity of product i. Suppose further that the ?AB, cross-price elasticity between the quantity demanded of A and the price of B, is 1/3, and that ?BA = 0.5. Finally, suppose that MCA = $200 and MCB = $300.

a. Based on this information, what prices would maximize profits if A and B were produced by two separate firms?

b. Are A and B complements or substitutes?

c. Does your answer to part b suggest that prices will be higher or lower when sold by a single firm than they would be if produced by two separate firms?

d. Fill in the following table. The first row contains the current values for PA, QA, PB, and QB.

PA QA PB QB %ΔPA %ΔQA %ΔPB %ΔQB TR
2147 2500 1500 4000
2100 1492 4000 -2.19% -0.53% 0%
2053 1343 -2.24% 0% -9.99%

e. Would you recommend changing the price of PA from $2147? If not, why not? If so, what type of change would tend to raise profit and why?

f. Would you recommend changing the price of PB from $1500? If not, why not? If so, what type of change would tend to raise profit and why?

Solution: The solution consists of 451 words (2 pages)
Deliverables: Word Document

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