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:
“I respect not his labors, his farm where everything has its price, who would carry the landscape, who would carry his God, to market, if he could get anything for him; who goes to market for his god as it is; on whose farm nothing grows free, whose fields bear no crops, whose meadows no flowers, whose trees no fruit, but dollars; who loves not the beauty of his fruits, whose fruits are not ripe for him till they are turned to dollars. Give me the poverty that enjoys true wealth.”
—Henry David Thoreau (1817–1862)
“Such is the power of love in gentle mind,
That it can alter all the course of kind.”
—Edmund Spenser (1552?–1599)
“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)
“Great things demand that we either remain silent about them or speak in a great manner: in a great manner, that is—cynically and with innocence.”
—Friedrich Nietzsche (1844–1900)