Suppose your firm develops a new pharmaceutical product that may be used to reduce blood cholesterol levels, so the firm is the monopoly seller of this drug. If the elasticity of demand for this new product is -4, what markup should your firm use to set the profit-maximizing price for the product?

A) The price-cost markup is 25% of the price.
B) The price-cost markup is 25% of the marginal cost.
C) The price-cost markup is 4% of the marginal cost.
D) The price-cost markup is 4% of the price.

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saagar chita · Accepted Answer

Final Answer : A, Explanation :  A monopolist maximizes profit by setting marginal revenue equal to marginal cost. The markup over marginal cost that the firm will charge depends on the elasticity of demand. In this case, the elasticity of demand is -4, which means that a 1% increase in price will result in a 4% decrease in quantity demanded. To maximize profit, the firm should set the price at a markup over marginal cost, which is the inverse of the absolute value of the elasticity of demand. In this case, the markup would be 1/|-4| = 0.25, or 25%. Therefore, the price-cost markup is 25% of the price.

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