solution

The Morrison Company produces tennis rackets, the marginal cost of a racket

being $20. Because there are many substitutes for the firm’s rackets, the price

elasticity of demand for its rackets equals about -2. In the relevant range of

output, average variable cost is very close to marginal cost.

a. The president of the Morrison Company feels that cost-plus pricing is

appropriate for his fi rm. He marks up average variable cost by 100% to

set price. Comment on this procedure.

b. Because of heightened competition, the price elasticity of demand for the

firm’s rackets increases to -3. The president continues to use the same

cost-plus pricing formula. Comment on its adequacy.