here again we have a market where producers have Market power while this point here is best where demand or consumers willingness to pay crosses with marginal cost which is the producer's supply instead these producers will exercise their Market power to restrict production and mark up the price they will choose where marginal revenue crosses with marginal cost and the willingness to pay of the marginal consumer will set the price but what if demand looked differently perhaps a bit flatter or what we call more elastic firms with Market power will still restrict production but they're pulling that price up a shallower slope and so the markup won't be as high and neither will the deadweight loss that results from the markup the elasticity of demand is really important when it comes to Monopoly markup remember that the price elasticity of demand is a measure of how responsive consumers are to price changes we calculate the price elasticity of Demand with this equation it's the percent change in the quantity demanded divided by the percent change in the price we can use the absolute value of the price elasticity of demand to classify how responsive consumers are demand is elastic when the absolute value is greater than one unit elastic when it's equal to one and inelastic when it is less than one remember due to the law of demand the price elasticity of demand will always be negative which is why we need to take the absolute value here how elastic demand is depends on a lot of factors consumers will be sensitive to price changes when there are many substitutes they can turn to instead and less responsive when there are few substitutes when Ford Motors raises their prices they'll lose many customers who will turn to substitutes like General Motors or Honda or Kia but when gasoline goes up in price people still fill up their tanks because there aren't as many alternatives for us to turn to but if you give people time to explore other Alternatives like carpools or increasing fuel efficiency they will react to that higher price more than they do with less time the more specific the product the more sensitive we are to the price compared to Broad categories we respond more to price changes for luxuries compared to necessities and we're often forced to make changes when the price change affects something that is a big part of our budget and we care less when it's only a tiny expense the markup rule shows us The Profit maximizing price for a monopolist based on the price elasticity of demand as the pricey elasticity of demand increases the monopolist's price approaches marginal cost meaning the more elastic demand is the lower the Monopoly markup will be we can apply some numbers to this equation to see how it works suppose the elasticity of demand is negative two which we would classify as elastic and means a one percent increase in the price will result in a two percent decrease in the quantity demanded and the marginal cost for the monopolist will say is five dollars plugging those values into the formula we see that we end up with negative 2 divided by negative one which is positive 2 times 5 which gives us a price of ten dollars it only costs the monopolist five dollars to produce the last unit but they will sell it for ten dollars meaning they're marking the price up by five dollars so what happens if we make demand more elastic if the price elasticity of demand is negative three which would be more elastic then the markup rule tells us that the monopolist will only charge seven dollars and fifty cents rather than ten dollars so the markup goes down from five dollars to two dollars and fifty cents and if we plug in negative six for the price elasticity of demand the monopolist price Falls to six dollars which is a markup of only one dollar the more elastic demand is the lower the markup so how can firms with Market power use this information to increase their profits well they want to charge higher prices to customers with fewer Alternatives and lower prices to customers more sensitive to the price second degree price discrimination also called bulk pricing is when a firm varies the price based on the quantity purchased you've probably seen a lot of this when shopping offers like buy one get one free is bulk pricing where the price per unit changes when you buy more this pricing strategy only works when the people who want to buy larger quantities have more elastic demand this is often the case when it comes to groceries families with children often need to buy larger quantities than smaller families or individuals would and larger families are also more price sensitive because groceries are a larger part of their overall budget and they're typically willing to spend more time searching for alternatives so it makes sense to give these price sensitive customers discount the price could go the other way though with electronics like smartphones firms tend to raise the price significantly for those who want to buy more phone phones with better cameras or more storage space often have a much bigger markup because customers who want these features tend to think of their phone as more of a necessity and they're less willing to accept Alternatives and so the price goes up but remember bulk pricing only works if the elasticity of Demand correlates with the quantity people want to buy if it does then firms will find it more profitable to offer this bulk pricing there is also third degree price discrimination which is when a firm charges different prices to different groups price discrimination is hard to pull off because you need to be able to identify how much individual consumers are willing to pay but with group prices the consumers will self-sort into categories which correspond to differences in elasticity and willingness to pay think about your local movie theater a couple of adults going out to the cinema on a date are likely willing to pay a lot for the movie If Only to show off to their date but families with children seniors and students are more sensitive to the price and won't go if the price is too high so theaters typically offer those groups a discount notice also that these categories need to be enforceable in a way that prevents Arbitrage which is why they pay categories where customers can offer proof that they're part of that group segmenting the market like this doesn't have to be based on demographics though Roman Haas introduced poly methyl methacrylate otherwise known as acrylic in 1936 it had many applications in many different Industries it revolutionized Dentistry for example because it could be used safely to make fillings or dentures but it's also used to make Plexiglas which has many applications for industrial production we can return to our graph to see how this works for pmma the costs are the same whether Roman Haas produces it for Dentistry or for industrial purposes but with different elasticities for demand they have an incentive to try to segment the market and charge different groups different prices when it came to Dentistry there were few alternatives to pmma and the demand was inelastic but there were many Alternatives in industry and so the demand was very elastic Roman Haas segmented the market charging 22 dollars per pound to the dentists but only 85 cents per pound for industrial uses with a price difference that big there's a huge opportunity for Arbitrage some products are easier to Arbitrage than others a maid can charge different customers different prices easily because it's hard for me to buy their service cheap and sell them to you for a markup feeders can prevent Arbitrage by checking tickets at the door but when it came to pmma it was harder to enforce you could have a whole profitable company which just buys industrial pmma and sells it to the dentists in order to stop this from happening Roman Haas considered poisoning the industrial pmma so it would be toxic if used for Dentistry but they settled on just spreading a rumor that industrial PMA was laced with arsenic to scare people away from arbitraging their product