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)
“Every diminution of the public burdens arising from taxation gives to individual enterprise increased power and furnishes to all the members of our happy confederacy new motives for patriotic affection and support.”
—Andrew Jackson (1767–1845)
“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)
“I often accuse my finest acquaintances of an immense frivolity; for, while there are manners and compliments we do not meet, we do not teach one another the lessons of honesty and sincerity that the brutes do, or of steadiness and solidity that the rocks do. The fault is commonly mutual; however, for we do not habitually demand any more of each other.”
—Henry David Thoreau (1817–1862)