Restaurants and retail stores often give 10% se nior citizen discounts. Use the concept of elasticity to explain how this can be profit maximizing behavior

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Bunny GreenfelderLv2

7 Jul 2019

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The Disney Company regularly offers coupons good for discounted admissions into its amusement parks. However, they never offer any discounts on merchandise inside the parks (food; souvenirs; etc.). How can you explain this difference using the concept of price elasticity of demand? Be thorough in your answer.

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Imagine that a local retail market is monopolistically competitive. Each firm (and potential entrant) is identical and faces a marginal cost that is independent of output and is equal to $100 per unit. Each firm has an annual fixed cost of $300 000 per month. Because each active firm perceives itself facing a price elasticity of demand equal to -2, the inverse price elasticity condition implies that the profit-maximizing price for each firm is (P - 100) / P = ½ or P = 200. If each firm charges an equal price they will evenly split the overall market demand of 96 000 units per month.

a) How many firms will operate in this market at a long-run equilibrium?

b) How would your answer change if each firm faced a price elasticity of demand of -4/3 and charged a profit-maximizing price of $400 per unit?