Question

Question 2. Suppose you are in charge of sales at a pharmaceutical company, and your firm has a new drug that causes bald men to grow hair. Assume that the company wants to earn as much revenue as possible from this drug. If the elasticity of demand for your company’s product at the current price is 1.4, would you advise the company to raise the price, lower the price, or to keep the price the same? What if the elasticity were 0.6? What if it were 1? Explain your answer with diagram.

Answer 1

• The firm can earn maximum revenue, when marginal revenue is equal to marginal cost.
• This point is attained , where elasticity of demand = 1

• If the price elasticity is 1.4 , the suggestion would be to reduce the price.
• As when the price reduces the quantity demanded will be increased.
• This price should be reduced till the elasticity becomes unit elastic (ed = 1 )
• If the price elasticity is 0.6 , the price should be increased till it becomes unitary elastic.
• As stated in the question , the firm wants to earn maximum profit, the maximum profit position is when elasticity is equal to 1. Therefore, when elasticity is equal to one there should be no change in the prices and firm should try to continue at that point only.
• The figure shows the relationship between elasticity of demand and total revenue earned from the product.
• therefore to conclude with, if the firm want to make maximum revenue, they should maintain the level of elasticity equal to unitary elastic.