Question

The following relates to the Lerner Index.

Which of the following statements is (are) true?

I.	Firms have less power to take advantage of consumers in a market when consumers are very price sensitive.
II.	If P = $100 and MC = $60, the Lerner index = 0.40.
III.	If the price elasticity of demand is -2.0, the Lerner index is 0.50.
IV.	A monopolist has more mark-up power if | Ed| =0.25 rather than if | Ed| =10

Answer 1

(I) Lerner index measure the market power of a firm.

Lerner index(L) = [(P - MC) / P] = 1/ I EdI

=> L = 1 / I Ed I

Note: I Ed I is the absolute value of elasticity of demand

Higher the price sensitive demand, higher will be the IEdI

Higher the IEdI implies lower Lerner index value, thus, lower market power.

TRUE: Firms have less power to take advantage of consumers in a market when conusmers are very price sensitive.

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(II) L = (P-MC) / P

=> L = (100 - 60) / 100

=> L = 40 / 100

=> L =0.4

TRUE: If P = $100, MC - $60, the Lerner index is 0.4

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(III) Price elasticity of demand (Ed) = -2

=> I Ed I = 2

L = 1 / I Ed I

=> L = 1 / 2

=> L = 0.5

TRUE: If price elasticity of demand is -2, the Lerner index is 0.50

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(IV) Smaller the Ed, larger the value of L, larger the value of L means larger market power.

TRUE: A monopolist has more mark-up power if | E_d| =0.25 rather than if | E_d| =10