An endofaisle price promotion changes the price elasticity o

An end-of-aisle price promotion changes the price elasticity of a good from ?3 to ?4. Suppose the normal price is $36, which equates marginal revenue with marginal cost at the initial elasticity of –3.

What should the promotional price be when the elasticity changes to –4? (Hint: In other words, what price will equate marginal revenue and marginal cost?)

A. $25.60

B. $32.00

C. $19.20

D. $41.60

Solution

Option (B).

Lerner Index (LI) = - 1 / E = (P - MC) / P, where E = Elasticity, P: Price, MC: Marginal cost

When E = -3,

LI = -1 / -3 = 1/3

1/3 = (36 - MC) / 36

36 = 108 - (3 x MC)

3 x MC = 72

MC = $24

When E = -4,

LI = -1 / -4 = 1/4

1/4 = (P - 24) / P

P = 4P - 96

3P = 96

P= $32