Other things being equal, the markup above marginal cost that a monopolist charg

Question

Other things being equal, the markup above marginal cost that a monopolist charges will be: (A) zero if there are any substitutes for the monopolist's product. (B) lower when there are more substitutes for the monopolist's product. (C) higher when there are more substitutes for the monopolist's product. (D) the same, no matter the number of substitutes for the monopolist's product. Other things being equal, the markup above marginal cost that a monopolist charges will be: (A) zero if there are any substitutes for the monopolist's product. (B) lower when there are more substitutes for the monopolist's product. (C) higher when there are more substitutes for the monopolist's product. (D) the same, no matter the number of substitutes for the monopolist's product.

Explanation / Answer

The mark-up pricing rule is:

P = MC x [e / (1 + e)]

where e: Price elasticity of demand, which measures sensitivity of a price change on the quantity demanded.

As number of substitute goods increases, demand becomes more elastic, so 'e' increases.

As e increases, [e / (1 + e)] decreases. Therefore, P decreases.

So, Price above markup will be lower when there are more substututes.

Correct option (B)

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