Question

PART B features an essay-type question; the student is expected to provide a thorough discussion of the following statement:

“By defining the concept of the percentage markup of prices over marginal cost as

(P - MC/P) = - 1/ƐD, where ƐD refers to the price elasticity of demand of the monopoly firm, one can use this concept to determine the market power of this profit maximizing monopoly firm

Answer 1

Answer -
* Price charged by monopolist is greater than marginal cost of production and the extent to which price can exceed marginal cost depends on monopoly power which is measured by learner index of monopoly power i.e. (P - MC ) / P

This observation lead to two general conclusion about monopoly pricing -:
1) A monopolist will always operate in elastic region of demand curve (e >1).This is because for profit maximization MR=MC . Since MC is always positive so MR must MR also be positive which requires that elasticity should be gretaer than 1 .

2) Firm mark up over marginal cost varies inversely with elasticity of demand.