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456 CHAPTER 11 MONOPOLY AND MONOPSONY

By contrast, retailers believe that baby food and dis- demand for baby food and disposable diapers. If so,
posable diapers are not purchased impulsively. They the IEPR implies that we should see precisely what
believe that most consumers of these products put we do see: higher markups for chewing gum and
considerable thought into their purchase decisions candy than for baby food and disposable diapers.
and pay close attention to price when deciding how For these products, at least, grocery stores seem to
much to buy. This suggests that the demand for set retail prices in a manner that is broadly consistent
chewing gum and candy is less price elastic than the with the IEPR.

down, your profit goes up. Thus, at any point on the inelastic region of the market
demand curve, the monopolist can always find a point on the elastic region that gives
it a higher profit.
We can use the IEPR to reach the same conclusion. To see why, we start with the
(perhaps obvious) observation that marginal cost is positive. This implies that the
term 1 (1/ Q,P ) in equation (11.3) must also be positive. But the only way this term
can be positive is if Q,P is between 1 and q, that is, if demand is price elastic.
Thus, the IEPR implies that the monopolist’s profit-maximizing price and quantity
occur along the elastic region of the market demand curve.

THE IEPR APPLIES NOT ONLY TO MONOPOLISTS
The IEPR applies to any firm that faces a downward-sloping demand for its product,
not just to monopolists. Consider, for example, the pricing problem Coca-Cola faces.
Coca-Cola does not have a monopoly in the U.S. cola market: Pepsi is an important
competitor. Still, Coca-Cola and Pepsi are not perfectly competitive firms. In other
words, if Coca-Cola raised its price, it would not lose all its sales to Pepsi, and if it
lowered its price, it would not steal all of Pepsi’s business. The reason for this is that
product differentiation the two colas exhibit product differentiation, a condition in which two or more
A situation in which two or products possess attributes that, in the minds of consumers, set the products apart
more products possess from one another and make them less than perfect substitutes. Some people prefer the
attributes that, in the minds sweeter taste of Pepsi to the less sweet taste of Coke and would continue to buy Pepsi
of consumers, set the prod- even if it cost more than Coke. You might prefer the taste of Coke. Or you might be
ucts apart from one another
and make them less than indifferent about the taste but prefer Coca-Cola’s packaging or advertisements.
perfect substitutes. Differentiated products will have downward-sloping demand curves, even though
the sellers of the products are not monopolists. The optimal pricing decision for a
seller of a differentiated product can thus be characterized by a rule very much like
the IEPR. For example, the optimal price markups for Coca-Cola and Pepsi (denoted
by A and I, respectively) would be described by

A
P MC A 1
A
P
Q A, P A
I
P MC I 1

P I Q I , P I
In these formulas, are not market-level price elasticities of demand.
Q A , P A and Q I ,P I
Rather, they are the brand-level price elasticities of demand for Coca-Cola and Pepsi.