Dominick Salvatore Schaums Outline of Microeconomics, 4th edition Schaums Outline Series 2006

CHAPTER 11
Recent and Advanced
Topics in Market
Structure
11.1 THE LERNER INDEX AS A MEASURE OF A FIRM’S MONOPOLY POWER
The Lerner index (L) measures the degree of a firm’s monopoly power. L is given by the ratio of the difference
between price (P) and marginal cost (MC) to price, or by one over the absolute value of the price elasticity
of demand e. The value of L can range from zero (for a perfectly competitive firm) to one (for a monopolist).
EXAMPLE 1. If P ¼ $8 and MC ¼ $6 or e ¼ 4, then L ¼ ($8 2 $6)/$8 ¼ 0.25 or 1/e ¼ 1/4 ¼ 0.25. On the other hand,
if P ¼ $8 and MC ¼ $4 or e ¼ 2, L ¼ 0.50 and the firm has double the monopoly power of the firm in the previous case. For
a perfectly competitive firm, P ¼ MC and e ¼ 1, and so L ¼ 0. On the other hand, the smaller is MC in relation to P and the
smaller is e, the largest is L and the degree of the firm’s monopoly power.
11.2 THE HERFINDAHL INDEX AS MEASURE OF MONOPOLY POWER IN AN INDUSTRY
The Herfindahl index (H) is a measure of the monopoly power in an industry as a whole. H is given by the
sum of the squared values of the market sales shares of all the firms in the industry. That is,
H ¼ S 2 1 þ S2 2 þþS2 N
Where S 1 is the market sales share of the largest firm in the industry, S 2 is the market sales share of the second
largest firm in the industry, and so on, for all the N firms in the industry. In general, the greater is the value of H,
the greater is the degree of monopoly power in the industry.
EXAMPLE 2. With monopoly or a single firm in the industry, so that its market share is 100%, H ¼ (100) 2 ¼ 10,000. On
the other hand, if there are 100 equal-sized firms in the (competitive) industry, each with 1% of the market, H ¼ 100. For an
industry with 10 equal-sized firms, each with 10% market share, H ¼ 1000. For an industry with 11 firms, one with 50%
market share and the other 10 firms with 5% market share each, H ¼ 2,750.
11.3 CONTESTABLE-MARKET THEORY
According to the contestable-market theory, even if an industry has a single firm (monopoly) or only a few
firms (oligopoly), it would still operate as if it were perfectly competitive if entry is “absolutely free” (i.e., if
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