The
ability of a firm (or group of firms) to raise and maintain price above the
level that would prevail under competition is referred to as market or monopoly
power. The exercise of market power leads to reduced output and loss of
economic welfare.
Although a precise economic
definition of market power can be put forward, the actual measurement of market
power is not straightforward. One approach that has been suggested is the
Lerner Index, i.e., the extent to which price exceeds marginal cost. However,
since marginal cost is not easy to measure empirically, an alternative is to substitute
average variable cost. Another approach is to measure the price elasticity of
demand facing an individual firm since it is related to the firm’s price-cost
(profit) margin and its ability to increase price. However, this measure is
also difficult to compute. The actual or potential exercise of market power is
used to determine whether or not substantial lessening of competition exists or
is likely to occur.