You manage a company that competes in an industry that is comprised of four equa

ID: 1118663 • Letter: Y

Question

You manage a company that competes in an industry that is comprised of four equal-sized firms that produce similar products. A recent industry report indicates that the market is fairly saturated, in that a 10 percent industry-wide price increase would lead to a 18 percent decline in units sold by all firms in the industry. Currently, Congress is considering legislation that would impose a tariff on a key input used by the industry. Your best estimate is that, if the legislation passes, your marginal cost will increase by two dollars Based on this information, what price increase would you recommend if the tariff legislation is passed by Congress? Instruction: Enter your response rounded to the nearest penny (two decimal places).

Explanation / Answer

Find the elasticity of demand in the industry = -18%/10% = -1.8. There are four firms in the industry and marginal cost is going to increase by $2. The required price increase is

P* = MC (4E/4E + 1)

= 2 x (4*-1.8/4*-1.8 + 1)

= 2 x (-7.2/-6.2)

= 2.32

Hence price increase is recommended at $2.32

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