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 firm. 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.