Price/Cost Markup - Elasticity of Demand.
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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.
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 ...
Investing in reputation in relation to the economics of the Internet is studied and discussed in the solution.