Consider a monopoly facing a demand structure where the price elasticity of demand is −1.25.The optimal markup factor is:
A) 5 times marginal revenue.
B) 0.2 times marginal revenue.
C) 5 times marginal cost.
D) 0.2 times marginal cost.

Question

Quizplus · Accepted Answer

The optimal markup factor (M) for a monopoly firm facing a demand curve with price elasticity (-ε) can be calculated using the following formula:
M = (1/ε)
In this case, the price elasticity of demand is -1.25, so the optimal markup factor would be:
M = (1/-1.25) = -0.8
However, since the markup factor must be a positive value, we take the absolute value of -0.8 which gives us 0.8.

We know that the optimal markup factor is equal to the ratio of the markup over marginal cost (M= P-MC/MC), meaning
M = (P - MC) / MC  
Rearranging the formula gives us:
P = (1 + M) MC
Substituting the value of M that we just calculated, we get:
P = (1 + 0.8) MC = 1.8 MC

Therefore, the best choice is C because the optimal markup factor for this monopoly is 1.8 times the marginal cost.

Consider a Monopoly Facing a Demand Structure Where the Price