Lerner index. Causes and consequences of market monopolization

2024 Author: Henry Conors | [email protected]. Last modified: 2024-02-12 02:43

Despite the economic and legislative measures taken by the authorities of different countries to combat monopoly, this phenomenon remains quite common. The monopoly power of individual companies poses a serious threat to the development of the economy.

Monopolism and its sources

Monopoly is understood as the dominance of one producer (distributor) or a united group of such entities (cartels) on the market.

Main sources of monopoly:

1. Elastic demand. This factor, in turn, is determined by the presence of similar products on the market, the speed of buyers' reaction to price changes, the significance of the product for buyers, the saturation of the market, the variety of product functionality and its compliance with the income level of buyers.
2. Market concentration. Where 2-3 companies cover 80-90% of consumers, monopoly appears faster than in competitive markets.
3. Cooperation between companies. Actingtogether, sellers or manufacturers have more power.

Consequences of monopoly

A company with monopoly power deliberately limits the output of goods and sets inflated prices. It has no incentive to lower production costs. In addition, the firm incurs additional costs in order to maintain and strengthen its position.

Monopoly in the market leads to the following consequences:

• resources are wasted;
• society does not receive the necessary goods;
• no incentives to develop and implement new technologies;
• production costs are rising.

As a result, production is not as efficient as possible.

Monopoly price

One of the results of monopolism is the sole regulation of prices by the monopolist.

Under the monopoly understand the price, significantly diverging from its normal level, which could take place in a competitive environment. Under normal conditions, the price is formed as a result of this or that ratio of consumer demand and market supply. Under conditions of monopoly, the price is set by the dominant subject at the level that will provide him with excess profit and cover excess costs.

The monopoly price can be too high or too low. Overpriced is a consequence of the dominance of a large seller. If the market is dominated by a large buyer in the presence ofa large number of sellers, he will try to keep prices as low as possible.

Lerner index as an indicator of monopolization

The level of monopoly power and market concentration is measured using the rule of thumb, the Lerner index and the Garfindel-Hirschman index.

The Lerner coefficient was proposed in 1934. It is one of the earliest methods for determining the level of monopolization and calculating the losses incurred by society due to monopolists. Being simple and clear, this indicator clearly characterizes the consequences of monopolization. Today, it is used by economists around the world when assessing the welfare of society.

If a product is produced and sold under monopolization, then its price will always be higher than marginal cost. The Lerner Index is the result of dividing price minus marginal cost by price. The more price deviates from costs, the more value the index takes.

Calculation and interpretation of the Lerner index

Lerner index is calculated by the formula:

I_L=(P - MC)/P=- 1/e_d.

P is monopoly price and MC is marginal cost.

Perfect competition implies that one firm cannot influence the price level. The price is at the same level as the marginal cost (P=MC), respectively:

• P – MC=0;
• I_L=(P - MC)/P=0/P=0.

Any price increase relative to marginal cost indicates that the firm hasa certain authority. The maximum possible index value is 1, which is a sign of absolute monopoly.

The Lerner index can be expressed in another way - using the coefficient of elasticity:

• (P - MC) / P=-1/e_d;
• I_L=-1/e_d.

The indicator e_d characterizes the price elasticity of demand for the firm's goods. For example, if E=-5, then I_L=0, 2.

High level of monopolization does not always mean that the company is making super profits. It can spend so much money to maintain its credibility that all the profits received as a result of a price increase are leveled.

Manifestations of monopoly in Russia

During the transitional period of the 90s. the Russian economy was characterized by a high concentration in the sphere of production. The market was dominated by super-large organizations, the choice of business partners was severely limited. The success of the business was heavily dependent on energy supplies. Efficiency indicators of enterprises were falling, production volumes were falling, the technological process was in a state of stagnation.

In 1992, after liberalization, regional and sectoral monopolists became the main market players. Financing issues were handled by large firms at the expense of small partners, which created a problem of disproportion at the macro level.

Monopolists, without regard to consumers, inflated prices and received excess profits. The state did not havesufficiently powerful levers of influence on the price level. Legislation was unclear and state institutions too weak. Taking advantage of the situation, monopolists from various industries secretly united in cartels. There were cartels among sellers and buyers, as well as mixed ones.

With the advent of the new century, the situation has changed little. Almost all the monopolies formed in the 1990s continue to operate. Formally, decentralization has been carried out in some industries, but rising gas and electricity prices indicate that the monopolies are still strong. The disproportion generated by the strong influence of large market players became one of the causes of the 2008-2009 crisis.