How does elasticity affect the profit maximizing price point?

Mar 21, 2016

The profit maximizing price, P depends of elasticity and is given by:
$P = M C \left(\frac{\varepsilon}{\varepsilon + 1}\right)$

Explanation:

Price Elasticity theory maintains that long-term success and profitability depend upon ideal pricing, or producing a good to the point where the additional revenue of an extra unit of output equals the additional cost of producing that unit, i.e. MR=MC

Now $M R = \left(P + \frac{1}{\varepsilon}\right)$
Where $P = \text{price", MR="Marginal Revenue", varepsilon = "elasticity}$

Now for profit maximizing company $M R = M C$
$M C = \text{Marginal Cost}$

Thus $M R = M C = \left(P + \frac{1}{\varepsilon}\right)$ Solve for price
$P = M C \left(\frac{\varepsilon}{\varepsilon + 1}\right)$
The Above equation shows how the profit maximizing Price, P depends on elasticity.