Question

1. Refer to information in table 1. A cell phone company wants to devise pricing based on potential buyers’ differences in preferences. Differences in preferences are shown by the group elasticities in column 2. Marginal cost (MC) of the cell phone is $200.

Table 1: cell phone elasticities by consumer groups and marginal costs
Consumer groups	Price elasticity of demand	MC	Price
Working adults	-1.25	$200
High income households	-1.35	$200
Senior citizens	-1.7	$200
Students	-2	$200

1. If the base (undiscounted) price of the cell phone is $1000, based on the information in table 1, calculate optimal price of cell phone for each group using mark-up pricing rule.

Working Adults:

High income households:

Senior citizens:

Students:

2. Which group in table 1 should receive the most discount? Why?

3. Which group in table 1 should receive the least discount? Why?

Answer 1

Mark-up pricing rule is following

P = MC/[1 + (1/Ed)]

P = Price

MC = Marginal Cost

Ed = Price Elasticity of Demand

Consumer Group	Price Elasticity of Demand	Marginal Cost (MC)	Price (P)
Working adults	-1.25	$200	$1,000.00
High income households	-1.35	$200	$772.20
Senior citizens	-1.7	$200	$485.79
Students	-2	$200	$400.00

Working adults

P = MC/[1 + (1/Ed)]

P = 200/[1 + (1/-1.25)]

Optimal price for working adults = $1,000.00

High income households

P = MC/[1 + (1/Ed)]

P = 200/[1 + (1/-1.35)]

Optimal price for high income households = $772.20

Senior citizens

P = MC/[1 + (1/Ed)]

P = 200/[1 + (1/-1.7)]

Optimal price for senior citizens = $485.79

Students

P = MC/[1 + (1/Ed)]

P = 200/[1 + (1/-2)]

Optimal price for students = $400.00

The group with the highest elasticity of demand should receive the most discount. In other words, Students should receive the most discount. The fact that students have the highest elasticity of demand means that a decrease in price will cause the demand to increase to the highest among the students. This means that students will contribute the most in the increase in total revenue due to the discount that will reduce the price.

The group with the lowest elasticity of demand should receive the least discount. In other words, Working Adults should receive the least discount.