Lerner Index
Encyclopedia
The Lerner index, named after the economist Abba Lerner, describes a firm's market power
. It is defined by:
where P is the market price set by the firm and MC is the firm's marginal cost
. The index ranges from a high of 1 to a low of 0, with higher numbers implying greater market power. For a perfectly competitive firm (where P=MC), L=0; such a firm has no market power.
The main problem with this measure, however, is that it is almost impossible to gather the necessary information on prices and particularly costs.
The Lerner Index is equivalent to the negative inverse of the formula
for price elasticity of demand
facing the firm, when the price, P, chosen is that which maximizes profits available because of the existence of market power.
Note that
is here an expression of the firm's demand curve, not the market demand curve.
The Lerner index describes the relationship between elasticity and price margins for a profit-maximizing firm; it can never be greater than one. If the Lerner index can't be greater than one, then elasticity can never be greater than −1 (the absolute value of elasticity of demand can never be less than one). The interpretation of this mathematical relationship is that a firm which is maximizing profits will never operate along the inelastic portion of its demand curve.
The measure of market power known now as the Lerner index was formalized by Abba Lerner in 1934.
Market power
In economics, market power is the ability of a firm to alter the market price of a good or service. In perfectly competitive markets, market participants have no market power. A firm with market power can raise prices without losing its customers to competitors...
. It is defined by:
where P is the market price set by the firm and MC is the firm's marginal cost
Marginal cost
In economics and finance, marginal cost is the change in total cost that arises when the quantity produced changes by one unit. That is, it is the cost of producing one more unit of a good...
. The index ranges from a high of 1 to a low of 0, with higher numbers implying greater market power. For a perfectly competitive firm (where P=MC), L=0; such a firm has no market power.
The main problem with this measure, however, is that it is almost impossible to gather the necessary information on prices and particularly costs.
The Lerner Index is equivalent to the negative inverse of the formula
for price elasticity of demandPrice elasticity of demand
Price elasticity of demand is a measure used in economics to show the responsiveness, or elasticity, of the quantity demanded of a good or service to a change in its price. More precisely, it gives the percentage change in quantity demanded in response to a one percent change in price...
facing the firm, when the price, P, chosen is that which maximizes profits available because of the existence of market power.
Note that
is here an expression of the firm's demand curve, not the market demand curve.The Lerner index describes the relationship between elasticity and price margins for a profit-maximizing firm; it can never be greater than one. If the Lerner index can't be greater than one, then elasticity can never be greater than −1 (the absolute value of elasticity of demand can never be less than one). The interpretation of this mathematical relationship is that a firm which is maximizing profits will never operate along the inelastic portion of its demand curve.
The measure of market power known now as the Lerner index was formalized by Abba Lerner in 1934.