Lerner Index (Market Power) Calculator
Calculate the Lerner Index, an economics measure of a firm's market power defined as the markup of price over marginal cost as a fraction of the price.
How to use this tool
- Enter price (p) and marginal cost (mc) in the fields above.
- Results update instantly as you type โ or click Calculate.
- Read your lerner index and the full breakdown beneath it.
โ This tool provides general estimates for education only and is not financial, tax or legal advice. Figures may not reflect your situation โ verify with a qualified professional.
Formula
L = (P โ MC) รท P
Where: L = Lerner Index (0 to 1), P = price, MC = marginal cost
Under profit maximization: L = โ1 รท ฮตd, where ฮตd is the own-price elasticity of demand
L = 0 indicates perfect competition; L โ 1 indicates strong monopoly power.
How it works
The Lerner Index, developed by economist Abba Lerner in 1934, measures monopoly power as the percentage markup over marginal cost. Under perfect competition, price equals marginal cost and the index is zero. A monopolist with no close substitutes can sustain a higher markup, pushing the index toward one.
The index is theoretically linked to the inverse of the firm's own-price elasticity of demand at the profit-maximizing output level, providing a connection between observable price-cost data and underlying demand conditions.
Worked example
Firm charges $10, marginal cost is $6
- Price P = $10; Marginal cost MC = $6
- Markup = P โ MC = $10 โ $6 = $4
- Lerner Index = $4 รท $10 = 0.40
- Implied elasticity of demand = โ1 รท 0.40 = โ2.50
Lerner Index = 0.40, indicating the firm prices 40% above marginal cost. The implied price elasticity of demand is โ2.5.
Common mistakes to avoid
- Confusing average cost with marginal cost โ the Lerner Index uses MC, not average total cost; these diverge whenever fixed costs are significant.
- Entering a price below marginal cost and expecting a valid result โ a Lerner Index below zero is theoretically possible (predatory pricing) but the standard formula assumes P >= MC.
- Interpreting L = 1 as a firm charging an infinitely high price; it simply means MC = 0 (e.g., digital goods), so 100% of price is markup, not that prices are literally infinite.
Key terms
- What does a Lerner Index of 0 mean?
- A Lerner Index of 0 means price equals marginal cost โ the outcome in a perfectly competitive market where no firm has pricing power.
- What does a Lerner Index of 1 mean?
- A Lerner Index of 1 would imply zero marginal cost and infinite market power, a theoretical maximum not achievable in practice. Very high values (e.g., 0.7โ0.9) indicate strong monopoly or oligopoly power.
- What is marginal cost?
- Marginal cost is the additional cost incurred by producing one more unit of output. It reflects the variable cost of the last unit and is central to pricing decisions in economics.
- How is the Lerner Index used in antitrust analysis?
- Regulators and economists use the Lerner Index as evidence of market power in antitrust investigations. A persistently high index in a market may indicate barriers to entry, predatory pricing, or monopolistic behavior warranting regulatory scrutiny.
- What is the relationship between the Lerner Index and price elasticity?
- At the profit-maximizing output, L = โ1/ฮต, where ฮต is the own-price elasticity of demand. A firm facing inelastic demand (|ฮต| < 1) cannot be maximizing profit because it could raise price and increase revenue; the Lerner Index provides this consistency check.
Frequently asked questions
- What does a Lerner Index of 0 mean?
- L = 0 means price equals marginal cost, which is the outcome in perfect competition. The firm has no market power and earns zero economic profit on the marginal unit.
- How is the Lerner Index related to price elasticity of demand?
- Under profit maximization, L = -1 / elasticity of demand. A less elastic demand (consumers less sensitive to price) allows a higher markup and a larger Lerner Index.
- Can the Lerner Index exceed 1?
- No. Since L = (P - MC)/P and both P and MC are non-negative, the maximum value is 1 (when MC = 0). A result greater than 1 indicates a data or measurement error.