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:
“But the nomads were the terror of all those whom the soil or the advantages of the market had induced to build towns. Agriculture therefore was a religious injunction, because of the perils of the state from nomadism.”
—Ralph Waldo Emerson (1803–1882)
“...I am who I am because I’m a black female.... When I was health director in Arkansas ... I could talk about teen-age pregnancy, about poverty, ignorance and enslavement and how the white power structure had imposed it—only because I was a black female. I mean, black people would have eaten up a white male who said what I did.”
—Joycelyn Elders (b. 1933)
“One of the reforms to be carried out during the incoming administration is a change in our monetary and banking laws, so as to secure greater elasticity in the forms of currency available for trade and to prevent the limitations of law from operating to increase the embarrassment of a financial panic.”
—William Howard Taft (1857–1930)
“The basis of political economy is non-interference. The only safe rule is found in the self-adjusting meter of demand and supply. Do not legislate. Meddle, and you snap the sinews with your sumptuary laws.”
—Ralph Waldo Emerson (1803–1882)