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A monopolistic seller of sports cars has traced out the following demand curve: 10 customers have willingness to pay (WTP) of $100K each, another 10 customers have WTP of $150K each, another 10 customers have WTP of $200K each; and a further 15 customers have WTP of $250K. Each sports car costs $50K to produce, but the production process requires a fixed machinery investment of $1.5M as well. The seller is considering setting one of the following prices: I. A price of $150K II. A price of $200K III. A price of $250K What is the order of the profits, from greatest to least, generated by these three pricing schemes?1) II > I > III2) III > I > II3) I > II > III4) II > III > I

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Answer:

The answer is: 1) II > I > III

Explanation:

Pricing scheme I: $2 million profit

  • Price $150,000
  • Contribution margin = $150,000 - $50,000 = $100,000
  • 35 units sold x $100,000 = $3.5 million
  • profit = $3.5 million - $1.5M = $2 million

Pricing scheme II: 2.25 million profit

  • Price $200,000
  • Contribution margin = $200,000 - $50,000 = $150,000
  • 25 units sold x $150,000 = $3.75 million
  • profit = $3.75 million - $1.5M = $2.25 million

Pricing scheme III: $1.5 million profit

  • Price $250,000
  • Contribution margin = $250,000 - $50,000 = $200,000
  • 15 units sold x $200,000 = $3 million
  • profit = $3 million - $1.5M = $1.5 million

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