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:
“Have you not heard of that madman who lit a lantern in the bright morning hours, ran to the market place, and cried incessantly: “I seek God! I seek God!””
—Friedrich Nietzsche (1844–1900)
“There are times when they seem so small! And then again, although they never seem large, there is a vastness behind them, a past of indefinite complexity and marvel, an amazing power of absorbing and assimilating, which forces one to suspect some power in the race so different from our own that one cannot understand that power. And ... whatever doubts or vexations one has in Japan, it is only necessary to ask oneself: “Well, who are the best people to live with?””
—Lafcadio Hearn (1850–1904)
“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)
“Again and again I am brought up against it, and again and again I resist it: I don’t want to believe it, even though it is almost palpable: the vast majority lack an intellectual conscience; indeed, it often seems to me that to demand such a thing is to be in the most populous cities as solitary as in the desert.”
—Friedrich Nietzsche (1844–1900)