Market Power and Elasticity of Demand
Market power is the ability to raise price above marginal cost and earn a positive profit. The degree to which a firm can raise price above marginal cost depends on the shape of the demand curve at the profit maximizing output. That is, elasticity is the critical factor in determining market power. The relationship between market power and the price elasticity of demand (PED) can be summarized by the equation:
- P/MC = PED/(1 + PED)
Note that PED will be negative, so the ratio is always greater than one. The higher the P/MC ratio, the more market power the firm possesses. As PED increases in magnitude, the P/MC ratio approaches one, and market power approaches zero. The equation is derived from the monopolist pricing rule:
- (P - MC)/P = -1/PED
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Famous quotes containing the words market, power, elasticity and/or demand:
“At market and fair, all folks do declare,
There is none like the Boy that sold Broom, green Broom.”
—Unknown. Broom, Green Broom (l. 23–24)
“Of a truth, Knowledge is power, but it is a power reined by scruple, having a conscience of what must be and what may be; whereas Ignorance is a blind giant who, let him but wax unbound, would make it a sport to seize the pillars that hold up the long- wrought fabric of human good, and turn all the places of joy as dark as a buried Babylon.”
—George Eliot [Mary Ann (or Marian)
“A submissive spirit might be patient, a strong understanding would supply resolution, but here was something more; here was that elasticity of mind, that disposition to be comforted, that power of turning readily from evil to good, and of finding employment which carried her out of herself, which was from Nature alone. It was the choicest gift of heaven.”
—Jane Austen (1775–1817)
“The Gothic cathedral is a blossoming in stone subdued by the insatiable demand of harmony in man.”
—Ralph Waldo Emerson (1803–1882)