Question

1. Market power refers to the ability of a firm to charge a price in excess of marginal cost. The monopoly markup refers to how big is the difference between price and marginal cost. Show that the size of the monopoly markup depends on the elasticity of the demand curve. Illustrate this statement graphically, and provide a verbal explanation of no more than five sentences.

Answer 1

This is shown below-

The markup is the difference between the price customers are willing to pay and the Marginal Cost for the monopoly. The more inelastic the demand (fewer other options available and high customer need), the higher the markup, as can be seen. If demand is elastic, it means it drops a lot with a small increase in price and hence the markup cant be too high (left figure), but if the demand is inelastic (it doesnt drop too much with price), the markup can be much higher (right figure).