Microeconomics · Quick explainer
Monopoly power and the Lerner index
Everything the papers ask about monopoly power fits in ten lines and one formula. Read the ten lines, try the calculator, then do the questions.
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The whole topic in ten lines
- 1What it is. Monopoly power is a firm's ability to charge a price above its marginal cost.
- 2The benchmark. Under perfect competition P = MC, so there is no such power at all.
- 3The measure. Abba Lerner (1934) measured it by the share of the price that is margin over marginal cost: .
- 4Its range. 0 ≤ L < 1. Zero is perfect competition; the closer to 1, the more power.
- 5Where the firm produces. A profit-maximiser sets MR = MC, and .
- 6The key result. Substitute and rearrange: , the inverse elasticity rule.
- 7What it means. Less elastic demand means more power. A monopolist always produces where |e| > 1, on the elastic part of demand.
- 8The markup form. The same rule as a price: . With |e| = 2, price is twice marginal cost.
- 9Where power comes from. The elasticity of market demand, the number of firms, and how aggressively those firms compete with each other.
- 10What it doesn't say. A high L is not the same as high profit: average cost can still eat the margin. L measures pricing power, not profit or welfare loss.
The two formulas to remember
The second holds for a firm that maximises profit; the first is the definition and holds always.
Interactive
The calculator
L =0.4
Price₹50
Marginal cost₹30
Implied |e| (= 1 / L)2.5
Price as a multiple of MC1.67×
Substantial market power: a large share of the price is margin over marginal cost.
Quick one · from price and cost
A firm sells at ₹50 with marginal cost ₹30. Find L and the elasticity it must be facing.
- Lerner index.
- Elasticity.
Answer
L = 0.4, |e| = 2.5
Quick one · from elasticity
A monopolist faces |e| = 4 and has MC = ₹30. What price does it charge?
- Markup rule.
- Check.L = (40 − 30)/40 = 0.25 = 1/4 ✓
Answer
P = ₹40
Why the monopolist never sits on inelastic demand
If |e| < 1, MR is negative: selling one unit fewer would raise revenue and also save its cost. So the firm keeps cutting output until demand becomes elastic. That is also why L = 1/|e| never exceeds 1.
Watch out for
Traps
- Dividing by MC instead of P. L = (P − MC)/P. (P − MC)/MC is the markup over cost, a different number.
- Using L = 1/|e| for any firm. It holds at the profit-maximising point; the definition (P − MC)/P holds everywhere.
- Equating power with profit. A firm with large L can still make losses if its average cost is high.
Practice
Check yourself
A. Numbers
Problem 1
Price is ₹80 and marginal cost is ₹60. Find the Lerner index and the price elasticity of demand at the profit-maximising point.
Problem 2
Demand elasticity is −1.5 and marginal cost is ₹20. Find the profit-maximising price.
B. Concepts
1Under perfect competition the Lerner index is:
2For a profit-maximising monopolist, the Lerner index equals:
3Other things equal, a firm has more monopoly power when demand for its product is:
4A monopolist with positive marginal cost produces where demand is:
Try it on real questions
Eight past-paper questions on monopoly power
From IIT JAM, UGC NET, JNU, CUET-PG and the University of Hyderabad: the Lerner index, the inverse elasticity rule, and the social cost of monopoly power.
These are questions from the TestStop bank. A free account answers 10 a day, each with its worked solution; All-Access opens every set with no daily limit.
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