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)
“Depression moods lead, almost invariably, to accidents. But, when they occur, our mood changes again, since the accident shows we can draw the world in our wake, and that we still retain some degree of power even when our spirits are low. A series of accidents creates a positively light-hearted state, out of consideration for this strange power.”
—Jean Baudrillard (b. 1929)
“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)
“Most of the ladies and gentlemen who mourn the passing of the nation’s leaders wouldn’t know a leader if they saw one. If they had the bad luck to come across a leader, they would find out that he might demand something from them, and this impertinence would put an abrupt and indignant end to their wish for his return.”
—Lewis H. Lapham (b. 1935)