Suppose Orange Inc. sells MP3 players and initially has monopoly power because there are only a few close substitutes available to consumers. As more types of MP3 players are introduced into the market, the demand facing Orange becomes ________ elastic and the Lerner index achieved by the firm in this market ________. A) less, declines B) less, increases C) more, increases D) more, declines

Answer: D) more, declines

When more types of MP3 players are introduced into the market, the number of substitutes for Orange Inc.'s MP3 players increases. This makes the demand for Orange Inc.'s MP3 players more elastic because consumers have more alternatives to choose from. When demand is more elastic, a firm has less ability to set prices above marginal cost without losing significant sales, since consumers can easily switch to the substitutes. Hence, a company's monopoly power decreases as its product becomes more elastic in demand.

The Lerner index is a measure of a firm's market power, calculated as:

Lerner Index = (Price - Marginal Cost) / Price

The Lerner index would decline in this case because with more elastic demand, the firm could not sustain a large gap between price and marginal cost without losing customers to the competition. Therefore, as demand becomes more elastic, the Lerner Index, which signifies the degree of monopoly power, decreases.