Question

Managerial economists, as well as business economists, often are hired as consultants to firms
regarding the appropriate pricing policy and strategy to utilize so as to maximize economic
profits. Sometimes firms utilize what they believe is an optimal pricing policy and strategy, only
to discover that they are in fact not maximizing their economic profits, and hence not really
adding value to the business.

For each of the following scenarios, provide advice on the appropriate pricing policy and
strategy, including the profit-maximizing price(s), for each firm.

1.      The price elasticity of demand for a managerial economics textbook sold in the U.S. is
estimated to be -2.0, whereas the price elasticity of demand for managerial economics
textbooks sold overseas is estimated to be -3.0. The U.S. market requires primarily
hardcover textbooks with a marginal cost of $6; the overseas market is normally served
with soft cover textbooks, having a marginal cost which is $1.50 less. A textbook sales
firm wishes to set the appropriate prices in each market for this managerial economics
textbook. What advice would you give this firm with regards to its pricing policy and
strategy? Why?

2. An automobile manufacturer prices its automobiles utilizing a mark-up of 20% above its

per-unit costs of production. The manufacturer believes that this mark-up will fully
compensate the firm for the extraneous costs associated with producing automobiles and,
in addition, return a decent profit. Currently, the average cost of producing an automobile
to the firm is $10,000 and the price elasticity of demand for the manufacturer's
automobiles is -4 and the fum sells its automobiles for $12,000 each. What advice would
you give this firm with regards to its pricing policy? Why?

3. The California Corporation is composed of a marketing division and a production
division. The marginal cost of producing a unit of the firm's product is $8 per unit, and
the marginal cost of marketing the product is $6 per unit. Currently, the firm produces
6,200 units of the product, all of which is sold (i.e. transferred) to the marketing division
for use in its advertising. The marketing division, in turn, uses advertising and packaging
schemes to generate enough demand for the product so that it can be sold for $107 per
unit. There is no external market for the product made by the production division, as the
product is sold by the marketing division. The production and marketing divisions are
involved in a transfer pricing dispute, in that the marketing division argues that the
transfer price should be its marginal cost of $6 per unit while the production division
claims it should be its marginal cost of $8 per unit. What advice would you give this fum
with regards to dealing with the transfer pricing dispute? Why?

Answer 1