You are the manager of a gas station in a small town in the United States, and your goal is to maximize profits. Based on your experience, the elasticity of demand of Texans for a car wash is –2, and that of non-Texans is –1.5.Your marginal cost is $6.
What is the profit-maximizing price to charge a Texan for a car wash? What is the profit-maximizing price to charge a Californian for a car wash?
Price elasticity of demand (PED or Ed) is a measure used in economics to show the responsiveness, or elasticity, of the quantity demanded of a good or service to a change in its price. More precisely, it gives the percentage change in quantity demanded in response to a one percent change in price (ceteris paribus, i.e. holding constant all the other determinants of demand, such as income). Ed = change in quantity/change in price, it is also the slope of the demand curve. Profit-maximizing point is where MR = MC = $6. So, the profit-maximizing price to charge a Texan for a car wash will be $6*2 = $12. The profit-maximizing price to charge a Californian for a car wash will be $6*1.5 = $9.