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Investing in reputation

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Price/Cost Markup - Elasticity of Demand.

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Solution Summary

Investing in reputation in relation to the economics of the Internet is studied and discussed in the solution.

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Question A
The formula for the price-cost markup based on elasticity of demand is the following:

Where is the elasticity in absolute value. In this case, the absolute value of elasticity is 3.5. Therefore, this formula tells us that:

This implies that price will be 140% of the cost; in other words, this implies a 40% markup on the cost of the good.

Question B
In the case of the "loss leader", what matters is not the profits obtained from the loss leader (which will be negative, since it's being sold at a price below its cost), but the profits contributed by other items in the store. As you can see from the above formula, the price-cost markup is ...

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