The ‘monopoly markup’ is the degree to which a firm with market power can price above...

The ‘monopoly markup’ is the degree to which a firm with market power can price above marginal cost. Consider two scenarios. In the first, a local retailer is given a monopoly on selling lager (a kind of beer) in Lubbock County. In the second, the retailer is given a monopoly on selling all kinds of beer. In which scenario do you expect the monopoly markup to be proportionately larger? Your answer should include both graphical and verbal components.

Expert Solution

A monopoly can price its products above the marginal cost depending upon the elasticity of demand. Let price elasticity of demand be E
E = (dQ/dP) * P/Q
R = PQ
MR = dR/dQ = Q * dP/dQ + P * 1
MR = P (1/E) + 1)

The markup for price = (1/E) + 1, i.e. higher the elasticity of demand, lower is the markup.

In the two examples above, the lager consumers are expected to have lower price elasticity as they have a specific taste and will find it relatively difficult to change their preferences, however, in general consumers of beer will tend to have a higher price elasticity of demand and might switch (substitute) beer for wine, whisky etc.

Rahul Sunny answered 2 years ago

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