Lerner Index (Market Power Formula)
Lerner Index = (P - MC) / P.
Measure a firm's market power: how far its price exceeds marginal cost.
From 0 (competition) to 1 (monopoly).
The Formula
The Lerner Index (L), developed by economist Abba Lerner in 1934, measures a firm's degree of market power — its ability to set prices above marginal cost.
P is the selling price and MC is the marginal cost of production. In a perfectly competitive market, P = MC so L = 0. A monopolist with high barriers to entry can set L close to 1, charging a price far above cost.
The Lerner Index equals the negative inverse of the price elasticity of demand: L = −1/ε_d. A firm facing elastic demand (ε_d = −5) has L = 0.2 (20% markup). A firm with inelastic demand (ε_d = −1.5) has L = 0.67 (67% markup). This is why monopolists with inelastic demand (insulin, essential drugs) can charge extreme prices.
Typical Lerner index values: grocery retail ~0.05. Airlines ~0.2–0.4. Pharmaceuticals with patents ~0.5–0.9. Pure monopoly utilities ~0.6–0.9. Antitrust regulators use market power measures like the Lerner Index to assess whether a merger will harm consumers.
Variables
| Symbol | Meaning | Unit |
|---|---|---|
| L | Lerner Index (0 = competition, 1 = max monopoly) | Dimensionless |
| P | Market price | $ |
| MC | Marginal cost of production | $ |
Example 1
A drug costs $2 to manufacture and sells for $50.
L = (50 − 2) / 50 = 48 / 50
L = 0.96 (extreme market power — consistent with patent-protected drug monopoly)
Example 2
A grocery store sells bread for $3.50 with marginal cost $3.15.
L = (3.50 − 3.15) / 3.50 = 0.35 / 3.50
L = 0.10 (modest market power, consistent with competitive retail)
When to Use It
- Antitrust and competition law analysis
- Measuring market power in industrial organization research
- Explaining why regulated industries must justify their prices
- Intermediate and advanced microeconomics coursework