Your company has developed a drug called Matrox that is an effective treatment f

Question

Your company has developed a drug called Matrox that is an effective treatment for migraine headaches. You have just discovered that it can also be used for organ transplant patients to reduce the risk of organ rejection. The demand for migraine medications is considerably more elastic than the demand for drugs to reduce the risk of organ rejections. A study has indicated that the elasticity of demand for Matrox as a migraine medication is -4.0 but as a transplant drug it is -1.5. The marginal cost is $5 per dose. Assuming you can price differently for the two different types of customers of the same basic drug, what would be the prices in the two markets? Use MC = P 1 1 |e| for optimal pricing.

I already know the answers, I need a "play by play" or "step by step" procedure so I can gain additional clarity and understand the process in its entirety. Thanks!

Explanation / Answer

Optimal pricing relationship is:

MC = P x [1 - (1 / |e|)] where |e|: Absolute value of elasticity of demand ....... (1)

(a) Matrox as migraine medication.

here, MC = $5 and e = - 4, So |e| = 4

Plugging in the values in (1):

$5 = P x [1 - (1 / 4)]

$5 = P x (1 - 0.25)

P = $5 / 0.75 = $6.67

(b) Matrox as transplant drug

here, MC = $5 and e = - 1.5, So |e| = 1.5

Plugging in the values in (1):

$5 = P x [1 - (1 / 1.5)]

$5 = P x (1 - 0.67)

P = $5 / 0.33 = $15

So, price is set higher (lower) in the market with lower (higher) elasticity of demand.

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