Question

We write the percentage markup of price over marginal cost as StartFraction Upper P minus MC Over Upper P EndFraction P−MC P. For a​ profit-maximizing monopolist, how does this markup depend on the elasticity of​ demand? Why can this markup be viewed as a measure of monopoly​ power? Market power is the ability to charge a price above marginal cost.

Answer 1

For a profit maximizing monopolist, the markup equals the negative of the inverse of the price elasticity of demand. That is:

`(P - MC)/(P) = (1)/(E_(d) )`

Here
`E_(d)` represents the price elasticity of demand. This implies that the less elastic is the market demand, greater will be the monopoly power and vice versa.

Perfect competition is characterized by equality of price and marginal cost and each individual firm earns only zero profits in the long run. Thus, the higher the price a firm can set above its marginal cost, can be thought of as measuring the lack of competition or the degree of monopoly power.