Question

For both monopolists and monopolistically competitive firms, what determines the optimal markup over marginal cost? Is this something a firm could impact? If so how?

Answer 1

It is the elasticity of demand that determines the markup over the marginal cost and it is applicable to both monopolists and monopolistically competitive firms. It is decided as follows:

(P-MC)/P = 1/|E|

E = Elasticity of demand

A bigger value of elasticity, means demand being more elastic, and value of markup decreases. A smaller value of elasticity, makes demand to be relatively inelastic and markup value over the MC increases as price increases more.

It can be impacted by the firms, but differently by the monopolists and monopolistically competitive firms. a monopolistically competitive firm brings product differentiation in terms of quality, unique features and exclusivity that can cater the specific demand. It makes demand to be inelastic. In contrast to it, monopolist firm has market power or there are lack of substitutes in the market that can replace the monopolist's product. It makes demand to be inelastic and markup over marginal cost increases.