🔎 Elasticity, Markup, and Profit

The Following Are Equivalent. You are always either in the left column or the right column. If you are in the left column, everything in the left column is true.

Apple iPhone	Android phones
Consumers are less price sensitive	Consumers are more price sensitive
Less Elastic	More Elastic
Suppose Ed = -1.5. $|E_d| = 1.5$, and 1.5<4, so we say this is “less elastic” than the other column. In this case, both sides of the following equation are relatively large: $$\frac{P - MC}{P} = -\frac{1}{E_d} = \frac{2}{3} = 0.67$$ It means that P-MC is two thirds of P. The markup that I pay (of Price over MC) is two thirds of the entire price that I’m paying. Only one third is the actual marginal cost. Alternatively, for every 1 part of MC that it costs to make the good I enjoy, there is 2 parts of markup that I am paying to their shareholders.	Suppose Ed = -4. $|E_d| = 4$, and 4>1.5, so we say this is “more elastic” than the other column. In this case, both sides of the following equation are relatively small: $$\frac{P - MC}{P} = -\frac{1}{E_d} = \frac{1}{4} = 0.25$$ It means that P-MC is one fourth of P. The markup that I pay (of Price over MC) is only one fourth of the entire price that I’m paying. A full three fourths is the actual marginal cost. Alternatively, for every 3 part of MC that it costs to make the good I enjoy, there is 1 part of markup that I am paying to their shareholders.
More markup	Less markup
More market power = monopoly power = pricing power	Less market power = monopoly power = pricing power
More firm profit	Less firm profit
(more deadweight loss) DWL comes from firms raising prices above MC so that fewer people end up consuming the good. (fewer that the efficient amount.)	(less deadweight loss) Less DWL because the number of people consuming the good is closer to the efficient amount.
Relatively steep demand curve	Relatively flat demand curve

Two extremes

Perfectly Steep Demand Curve (Vertical)	Perfectly Flat Demand Curve (Horizontal)
The monopolist is in complete control	This is like a competitive market.
Customers will pay whatever you charge (“Pharma Bro”)	Perfectly Elastic
Ed = 0 $$ $$ means that if you raise your price, you lose NONE of your customers.	Ed = -∞ $$ $$ means that if you raise your price, you lose ALL of your customers.
$$\frac{P - MC}{P} = -\frac{1}{E_d} = 1 = 100$$ 100% of price is markup	$$\frac{P - MC}{P} = -\frac{1}{E_d} = 0$$ none of the price is markup

Some facts about elasticity

• Official name: “Price Elasticity of Demand”
• If the demand curve is down sloping, it is always negative.
• When a monopolist is optimizing, it is always less than -1.
• Formula is E_d = $\frac{\%\Delta Q^D}{\%\Delta P}$ ← intuition behind the formula is the E_d tells you how much Q^D changes when you increase the price by 1%. For example, if E_d=-1.5, then when you increase the price by 1%, the quantity people demand changes by $-1.5 \times 1\% = -1.5\%$. You raise your price by 1% and you lose 1.5% of your business. Similarly, if E_d=-4, then when you raise your price by 1%, you lose 4% of your sales. If E_d=-1.5 and you raise your price by 2%, then you lose $-1.5 \times 2\% = 3\%$ of your sales.

$E_d = \frac{\%\Delta Q^D}{\%\Delta P} \quad \text{⇨} \quad E_d \times \%\Delta P = \%\Delta Q^D$