Assume you have been hired to advise two different firms, A and B, regarding the

Question

Assume you have been hired to advise two different firms, A and B, regarding the price each firm should charge for its product, focusing on the amount each firm should mark up price over marginal cost. Whicle both firm sare price setters, the product produced by firm A is extremely unique and enjoys widespread appeal. In contrast, firm B sells a fairly standard product for which there are several good, but not perfect, substitutes. How would your advice to each firm differ? How does the price elasticity of demand influence your recommendations?

Explanation / Answer

Now Price elasticity of demand will be different for each firm. As Firm A product is unique so it will not be having substitutes and people will not be able to shift to other product even when prices rise. So here demand is inelastic to price.

For Firm B the people will be able to shift to sufficiently good substitutes when prices rise so the demand will be relatively elastic to firm A.

Now due to this difference in elaticity the recommenfations will be different as Firm A will be able to survive and flourish with higher prices while Firm B will not B able to as people will shift to substitutes for Firm B product when price rises.

So my advice to firm A would be to add sufficiently good markup price over MC to earn greater profits while my advice to firm B will be that the markup price over MC should be minimal as buyers will shift to substitutes in response to a higher price

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