Monopoly in Economics: Definition, Examples and Lerner Index
Definition of Monopoly
Monopoly in economics is a market where there is only one supplier of a certain good or service, and therefore has great power and influence in it.
The monopolist can benefit from its price control and have a negative impact on society, since it can impose disproportionate prices because it’s the only option for the acquisition of a good or service.
In addition, because it doesn’t have to face competition, the quality standards in their activity can be neglected, unlike a perfect competition market where producers compete to be the best.
Constitutions around the world prohibit monopoly (1) and promote markets with the greatest possible equilibrium, trying to be the most similar to a perfect competition market.
The opposite of monopolization is monopsony which refers to the market in which there is only one buyer and many sellers.
Real examples of Monopoly
These two cases are somehow an example of modern monopolies:
Google: Google is the most popular web browser and has over 70% of market share.
Microsoft: Microsoft is a company that manufactures computers and softwares. It holds more than 75% of market share.
Lerner index and monopoly Power
Monopoly power can be of a greater or lesser degree and can be measured with a formula.
There is a measure of monopoly power, presented by the economist Abba Lerner in 1934, called the Lerner monopoly index, and it is represented, in mathematical terms, as:
Formula
L= -(1/Ed)
Where Ed is the elasticity of the firm’s demand curve. This index always has a value between zero and one. The larger the value of L, the greater the Monopoly Power.
But, when L takes a value closer to 0, the company is closer to perfect competition.
Given a firm A with an elasticity of demand –6 and another B, with an elasticity of demand -5, which one has more monopoly power?
Example of Lerner Index
After applying Lerner’s mathematical formula for determining monopoly power and determining the prices of both companies, it is concluded that company B, with elasticity of demand – 5, has a higher level of monopoly.
Will a company with greater monopoly power have more benefits than the others?
A company with monopoly power will not necessarily have a higher profit than the others (2). The reason for this is that its profits depend on the average cost in relation to the price, if the company has very high average costs, the profit will not be as high even if it has such power.
While others, despite not having it, can have greater benefits if they have lower costs.