Lerner index

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The Lerner index is a tool used in the microeconomic study to know the degree of monopoly of a society or sector. It is expressed mathematically as (L).

This economic measure was introduced by Abba Lerner in 1934 in order to estimate the market power of a commercial company.

The use of this measurement makes it easier to estimate what role companies play in all types of markets, taking into account different variables, such as how atomized or concentrated they are (if the number of competitors is high or low), or their costs when performing the tasks. activities they focus on to compete.

The Lerner index and market power

The Lerner index studies the percentage belonging to the market price that is set beyond cost. In other words, what capacity does the company under study have to establish its price above its marginal cost. The explanation is the following:

With a monopolistic nature, the fixed price will be higher, in search of greater benefits. On the contrary, if there are a large number of rivals, prices tend to be closer to the costs of production or acquisition. This, to attract customers and gain market share.

It should be noted that in markets with greater monopolistic character, companies obtain greater power and benefits. However, for the consumer or buyer it is an unfavorable situation because they face higher prices and fewer goods or services among which to establish their preferences.

Among the factors or variables mentioned above that affect the Lerner index are the number of substitute products on the market and the number of companies that operate.

On the one hand, the fewer substitute goods there are, the lower the price elasticity of demand. Regarding the number of companies, the greater the number of rivals, the less market power each one has.

Lerner index formula

The simplest or simplest mathematical calculation when it comes to knowing the Lerner index of a company is performed by finding the difference between P (price) and CM (marginal cost) and dividing the result by the price:

Another alternative way to obtain this index is by calculating the multiplicative inverse of the absolute value of the price elasticity of demand:

In both cases, the value obtained goes from 0 to 1. In this sense, values ​​close to 1 will mean great market power and those close to 0, little market power. If in a sector the values ​​are close to zero, we could think that we are approaching a case of perfect competition. On the other hand, if the values ​​are close to 1, we are facing a case of monopolistic competition.

Example of the Lerner index

We have two companies, A and B. The first participates in a market focused on the production of a novel electronic device where there are not many companies. A offers a rare commodity almost exclusively, so it sets high prices without worrying too much. Its price is 5 and its marginal cost is 1, both quantities per unit.

L = (5-1) / 5 = 4/5 = 0.88

We also have B, a manufacturer of dairy products that operates in a market with many rivals. To compete, set low prices to stand out. Its price per liter of milk is 1.5 and its marginal cost for the same quantity is 1.

L = (1.5-1) / 1.5 = 0.5 / 1.5 = 0.33

The Lerner index estimated for A is close to 1, confirming its high market power and ability to set prices, while that of B, being closer to the value 0, shows that it does not have a large share or influence.

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