A firm produces a product with a fully allocated average cost equal to $20. If the price elasticity of demand for the product is -5, then the product price should be set at
A) $25.
B) $24.
C) $23.
D) $22.

Question

Quizplus · Accepted Answer

To maximize profit, the firm should set the price where marginal cost equals marginal revenue. Using the formula P = MC / (1 + 1/E), where E is the price elasticity of demand, we get P = 20 / (1 + 1/(-5)) = 20 / (1 - 0.2) = 20 / 0.8 = $25.

A Firm Produces a Product with a Fully Allocated Average