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
Read more about this topic: Market Power
Famous quotes containing the words market, power, elasticity and/or demand:
“Forbede us thing, and that desiren we;
Preesse on us faste, and thanne wol we flee.
With daunger oute we al oure chaffare:
Greet prees at market maketh dere ware,
And too greet chepe is holden at litel pris.”
—Geoffrey Chaucer (1340?–1400)
“But the relationship of morality and power is a very subtle one. Because ultimately power without morality is no longer power.”
—James Baldwin (1924–1987)
“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)
“We are well advised to keep on nodding terms with the people we used to be, whether we find them attractive company or not. Otherwise they turn up unannounced and surprise us, come hammering on the mind’s door at 4am of a bad night and demand to know who deserted them, who betrayed them, who is going to make amends. We forget all too soon the things we thought we could never forget.”
—Joan Didion (b. 1934)