Explain how the profit-maximizing price is calculated. Why is the profit-maximizing price extremely difficult to calculate for an actual product?© BrainMass Inc. brainmass.com October 7, 2022, 5:30 pm ad1c9bdddf
SOLUTION This solution is FREE courtesy of BrainMass!
The exact method to calculate a profit maximizing price is to determine the elasticity of a product. Elasticity refers to how changes in price affect demand. The more elastic the product is, the greater the changes in demand that are in direct relation to price. Basically, when prices go up, demand drops. We do this by calculating 1+the change in percentage of the quantity sold of the product divided by 1+ the percentage change that took place in the price of the product. The variable costs of the product is then multiplied by the elasticity ratio that we calculated first, and that total is divided by 1+ the product's elasticity. This is why most firms don't use it -- it is way too time-consuming and too difficult to use, especially when we take into consideration the number of products that many companies offer. It's just not a realistic method.
This is difficult to calculate (other than the calculation itself) because each product will have a different elasticity, in many cases. Johnson and Johnson is a good example. They sell aspirin, which for most of us that don't need it for medical reasons other than the occasional headache is highly elastic because there are many generic substitutes. They also make drugs for heart patients that they have patented, which there are no generics for, which are highly inelastic because changes in price will not affect demand, people have to have their heart medicine. Another factor is that variable costs are constantly changing. As variable costs drop, the profit maximizing price would have to be recalculated because it takes variable costs into consideration as part of the actual equation.
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