Question

4. EFG Manufacturing has a product that sells for $15 per unit, and the marginal cost is $5.00.

a. Compute the Lerner index for EFG Manufacturing.

b. If this index indicates market power, under what condition(s) will this market power last in the long-run? Explain.

Answer 1

A) Lerner index = (P - MC) / P

= (15 - 5 ) / 15

= 10 /15

= 0.667

B)  Lerner index helps in measure of the market power of a firm. the index measures the % markup that a firm is able to charge over its marginal cost. The index ranges from a low value of 0 to a high value of 1. The higher the value of the Lerner index, the more the firm is able to charge over its marginal cost or vice versa, hence the greater its monopoly power.

Pricing power

The ability of companies to make above “normal profit”: firm having higher market power only earn more than normal profit i.e supernormal profit, like monopoly

Perfect information: If an industry enjoys a perfect flow of information and there is no mismatch between real facts and information available to sellers, players will not achieve market power, to achieve market power rumors are required

Factor mobility: If an industry provides unequal ease of access to inputs of its products or services, the market power of individual firms will be better off.

Barriers to entry or exit: barriers to entry means existing firms are protected because few new firms can interrupt market

these above points are some conditions where market power last in the long run