Comparing your answers to the previous two questions, at a price of $8 Salt City Donut’s markup is
[ Select ]
larger
smaller
than its inverse elasticity, meaning that it should
[ Select ]
raise
lower
its price.

Question

Comparing your answers to the previous two questions, at a price of $8 Salt City Donut’s markup is 
[ Select ]
larger
smaller
 than its inverse elasticity, meaning that it should 
[ Select ]
raise
lower
 its price.

BlackTom AI · Accepted Answer

The question asks us to compare Salt City Donut’s markup to its inverse elasticity and then decide how to adjust price accordingly. 
First, recall that the markup is typically described by the Lerner index: (P − MC)/P = 1/|ε|, where ε is the price elasticity of demand. The term 'inverse elasticity' refers to 1/|ε|. In this framework, the markup and the inverse elasticity are tied together: when the markup exceeds the inverse elasticity, the firm is charging a price that is too high relative to the elasticity of demand; the intuitive impulse is to soften the price, i.e., lower the price, to move toward the efficient balance where markup matches the inverse elasticity. 
Option 1 analysis: 'larger' versus 'smaller' as the comparison between markup and inverse elasticity. If we interpret the premise as markup being larger than the inverse elasticity, this indicates the price is set too high given demand sensitivity, supporting a need to reduce the markup by lowering price. If instead the markup were smaller, the natural move would be to raise price to increase the markup toward the inverse elasticity level, though that would depend on the actual elasticity estimate. 
Option 2 analysis: 'raise' versus 'lower' as the recommended price adjustment. Given markup > inverse elasticity, the correct corrective action is to reduce the price (lower it) to bring the markup down toward the inverse elasticity value. Conversely, if the markup were smaller than the inverse elasticity, a strategic move to raise price would be more consistent with pushing the markup up toward the inverse elasticity benchmark. 
In sum, the combination 'larger' for the first blank and 'lower' for the second blank aligns with the standard interpretation of the Lerner index relationship: when markup exceeds 1/|ε|, price should be lowered to move toward the optimal markup level. 
Note: If any part of the premise were reversed (e.g., markup smaller than inverse elasticity), the recommended action would flip accordingly, with raising price being more appropriate in that hypothetical. The key idea is that price adjustments should move the observed markup toward the inverse elasticity benchmark, not away from it.

QAMO 2010-004 Fall 2025 Unit 5: Profit Maximization with Market Power Part 1 -- Short Problems

Comparing your answers to the previous two questions, at a price of $8 Salt City Donut’s markup is [ Select ] larger smaller than its inverse elasticity, meaning that it should [ Select ] raise lower its price.

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