CHAPTER 10 • Market Power: Monopoly and Monopsony 373 cost For a reasonably wide range of output levels (over which the size of the store and the number of its employees will remain fixed), marginal cost includes the cost of purchasing the food at wholesale, plus the costs of storing the food, arranging it on the shelves, etc For most supermarkets, the markup is indeed about 10 or 11 percent Small convenience stores, which are often open days a week and even 24 hours a day, typically charge higher prices than supermarkets Why? Because a convenience store faces a less elastic demand curve Its customers are generally less price sensitive They might need a quart of milk or a loaf of bread late at night or may find it inconvenient to drive to the supermarket Because the elasticity of demand for a convenience store is about −5, the markup equation implies that its prices should be about 25 percent above marginal cost, as indeed they typically are The Lerner index, (P − MC)/P, tells us that the convenience store has more monopoly power, but does it make larger profits? No Because its volume $/Q is far smaller and its average fixed costs are larger, it usually earns a much smaller profit than a large supermarket despite its higher markup Finally, consider a producer of designer jeans Many companies produce jeans, but some consumers will pay much more for jeans with a designer label Just how much more they will pay—or more exactly, how much sales will drop in response to higher prices—is a question that the producer must carefully consider because it is critical in determining the price at which the clothing will be sold (at wholesale to retail stores, which then mark up the price further) With designer jeans, demand elasticities in the range of −2 to −3 are typical for the major labels This means that price should be 50 to 100 percent higher than marginal cost Marginal cost is typically $20 to $25 per pair, and depending on the brand, the wholesale price is in the $30 to $50 range In contrast, “mass-market” jeans will typically wholesale for $18 to $25 per pair Why? Because without the designer label, they are far more price elastic $/Q P* – MC MC P* MC P* AR P* – MC MR AR MR Q* Quantity (a) Quantity Q* (b) F IGURE 10.8 ELASTICITY OF DEMAND AND PRICE MARKUP The markup (P − MC)/P is equal to minus the inverse of the elasticity of demand facing the firm If the firm’s demand is elastic, as in (a), the markup is small and the firm has little monopoly power The opposite is true if demand is relatively inelastic, as in (b)