## Market Power in Practice

• We’ve established some theory, now we can begin to look at how it can be applied in practice
• Market power is a continuous measure, not discrete
• All firms have some level of market power, even if it’s so small we ignore it
• In practice, we tend to define some threshold of market power that is worth caring about
• Graphical example

Consider two separate markets where two distinct firms hold a monopoly and face the same constant marginal cost curve.

• The key difference between the two firms is that Firm B faces a more elastic demand curve than Firm A (remember that a flatter curve = more elastic)

Claim: more elastic consumers pay a lower price

• From the graph, we saw that Firm A charges price $$P_1 = \16$$ and Firm B charges price $$P_2= \12.50$$. Additionally, the perfectly competitive price is equal to marginal cost ($$P_c$$ = $10) for both firms. • To prove our claim, first, we can find the Lerner index for both firms to find which firm has more power in the market: $\lambda_1=\frac{P_1-P_C}{P_1} = \frac{16-10}{16}=\frac{3}{8}$ $\lambda_2=\frac{P_2-P_C}{P_2} = \frac{12.5-10}{12.5}=\frac{1}{5}$ • Next, we can use our simplified equation for the Lerner index to solve for the elasticity of demand for both markets: $\lambda_1=\frac{1}{|\eta_1|} \Rightarrow |\eta_1|=\frac{8}{3}$ $\lambda_1=\frac{1}{|\eta_2|} \Rightarrow |\eta_2|=5$ If only one case can be prosecuted, which case would it be? • Suppose $$Q_c$$ where $$D_1=MC$$ and $$D_2=MC$$ are same across two markets. • The social welfare loss loss is greater in market 1 than in market 2. • This means that it may be socially optimal to press charge on firm 1 operating in market 1 if only one case can be prosecuted due to antitrust enforcement cost (each case takes on average 24 months and costs on average$200,000-\$250,000).

### Excess Profit

• Along with Lerner indices, excess profit can be helpful in measuring market power

• Excess profit – firms earning greater return on its resources than necessary
• Excess profit – more entrants into the market
• If we do not observe entrants over time, we expect there to exist some form of barrier to entry (and some degree of market power for the firm enjoying excess profit)
• Accounting data is easy to collect; however, this data is not equivalent to economic profit

• For the purposes of this class, we will calculate economic profit by including depreciation and opportunity cost

$\Pi^e = p\cdot q - TC(q)-D-\gamma$

• D is economic depreciation of capital stock
• $$\gamma$$ is the opportunity cost of the asset (or, in the case of a firm supplying a good, $$\gamma$$ is the opportunity cost of producing q units)
• $$D$$ and $$\gamma$$ are very difficult to measure in practice