4The elasticity of demand in the local hardware industry is2

4·The elasticity of demand in the local hardware industry is-2, while in the video market it is-5. Which industry has a higher markup over marginal cost (as a percentage of price)? In answering, calculate the markup for each. 5. The local bottled water supplier sells water for $0.40 per gallon, while marginal cost is $0.25 per gallon. What is this firm\'s degree of monopoly power, as measured by the Lemer index? 6. What is a network externality? And why might goods that exhibit this extenality be more likely to be provided by monopoly suppliers

Solution

4) We know that P = MC *(E/E + 1) where E is the value of elasticity. This is implified as -1/E = P - MC/P which is the mark up against price. Now that E is -2 in hardware industry and E is -5 in video market, we have the following mark ups

Mark up in hardware industry => (P - MC)/P = (-1/-2)*100 = 50%

Mark up in video market => (P - MC)/P = (-1/-5)*100 = 20%

Hence,  hardware industry has a higher markup

5) Lerner index is (P - MC)/P = (0.40 - 0.25)/0.40 = 0.375. A value close to zero reflects price and marginal cost are close which implies strong competition. Here it is close to 0.4 so there is a weak monopoly power and a strong competition faced by the supplier

6) Network externalities can exist for a particular good when the individual considers a good more valuable when there are other people in the marker who are using it and it becomes more and more valuable as more and more people are able to use it. This is also called complementarity in consumption and production. Since there is a large number of buyers for a particular good produced by one firm (MS-WORD, for example), the production company gradually acquires monopoly power.