Define market power in terms of market structure; why is market power equal to zero in...

Define market power in terms of market structure; why is market power equal to zero in competitive equilibrium ? (Note: A commonly used metric for market power is the Lerner Index, defined as : =(p-MC)/MC.

Expert Solution

Market power can be defined as the ability of a firm (or group of firms) to manipulate the price of a product with the manipulations in the level of demand, supply, or both. The Lerner Index (=(p-MC)/MC) refers to the measure of market power: the ability of a firm to increase the price above marginal cost. Lerner Index equal to zero (L = 0) for the perfectly competitive firm because the price is equal to marginal cost (P = MC). Cournot firm’s Lerner Index would be depending on the elasticity that the firm experiences. There is an inverse relationship between elasticity of demand and Lerner Index i.e. -1/Ed. The perfectly-competitive firm will not set its price higher than its marginal cost because it has a horizontal demand curve thus indicating that if the firm charge a price exceeding its marginal cost, it will experience a zero revenue because the customers will switch to its competitors

Rahul Sunny answered 7 months ago

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