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)
“Many a reformer perishes in his removal of rubbish,—and that makes the offensiveness of the class. They are partial; they are not equal to the work they pretend. They lose their way; in the assault on the kingdom of darkness, they expend all their energy on some accidental evil, and lose their sanity and power of benefit.”
—Ralph Waldo Emerson (1803–1882)
“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)
“Our frigate takes fire,
The other asks if we demand quarter?
If our colors are struck and the fighting done?
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We have not struck, he composedly cries, we have just begun our part of the fighting.”
—Walt Whitman (1819–1892)