Lerner Index of Market Power

Definition

The Lerner Index of Market Power measures the extent to which a firm can set prices above its marginal cost. It is calculated by subtracting the firm's marginal cost from its price, and then dividing that difference by the price.

Analogy

Imagine you're at a concert and there are two merchandise stands selling t-shirts. Stand A charges $20 per shirt, while Stand B charges $10 per shirt. If both stands have the same cost to produce each shirt, Stand A has a higher Lerner Index of Market Power because they are able to charge more than their production cost.

Related terms

Barriers to Entry: These are obstacles that make it difficult for new firms to enter an industry, such as high startup costs or government regulations.

Economies of Scale: This refers to the cost advantages that larger firms have over smaller ones due to factors like increased production efficiency and lower average costs.

Monopoly Power: This term describes a situation where one firm has complete control over a market, allowing them to set prices without competition.