Microeconomia
David A. Besanko, Ronald R. Braeutigam
Copyright © 2009 – The McGraw-Hill Companies srl
11.2
T H E I M P O R TA N C E O F P R I C E E L A S T I C I T Y O F D E M A N D
429
prefer the sweeter taste of Pepsi to the less sweet taste of Coke and would continue
to buy Pepsi even if it cost more than Coke. You might prefer the taste of Coke.
Or you might be indifferent about the taste but prefer Coca-Cola’s packaging or
advertisements.
Differentiated products will have downward-sloping demand curves, even though
the sellers of the products are not monopolists. The optimal pricing decision for a
seller of a differentiated product can thus be characterized by a rule very much like the
IEPR. For example, the optimal price markups for Coca-Cola and Pepsi (denoted by
A and I, respectively) would be described by
P A − MC A
1
=−
PA
Q A , PA
P I − MC I
1
=−
I
P
Q I , PI
In these formulas, Q A, PA and Q I , PI are not market-level price elasticities of demand.
Rather, they are the brand-level price elasticities of demand for Coca-Cola and Pepsi.
Thus, Q A, PA tells us the sensitivity of Coca-Cola’s demand to Coca-Cola’s price, holding all other factors affecting Coke’s demand (including Pepsi’s price) fixed.7
A P P L I C A T I O N
11.2
Market Power in the Breakfast
Cereal Industry
In the spring of 1995, two U.S. congressmen, Charles
Schumer of New York (later a senator from New York)
and Sam Gejdenson of Connecticut, accused the four
largest cereal companies—Kellogg, General Mills, Post,
and Quaker Oats—of collusion to keep prices high. Citing
evidence that cereal prices increased at twice the rate
of other food prices between 1983 and 1990, Schumer
urged Attorney General Janet Reno to investigate cereal
industry pricing. “There is no real competition in this
industry,” said Schumer. “We are paying caviar prices for
corn flakes quality.” Asked if there was evidence that the
cereal producers were colluding, Gejdenson responded:
“Price is the prima facie evidence.”8
7
Why are cereal prices so high? Is it because Kellogg, General Mills, Post, and Quaker Oats collectively
act as a monopolist? Or are the high prices a natural
outcome of competition in a market in which there is
significant product differentiation?
Economist Aviv Nevo has studied this question.9
Using data on cereal prices, product characteristics, and
consumer demographics (e.g., household income), he
estimated price elasticities of demand for each brand
of cereal. Nevo then used these estimated elasticities
to compute the Lerner Indices that would be expected
to prevail under two scenarios: one in which cereal producers collectively act as a profit-maximizing monopolist and the other in which the producers compete as
independent firms in a market with differentiated
products.10 Given his estimated demand elasticities,
Nevo concluded that in a collusive cereal industry, the
See Chapter 2 for a detailed discussion of the difference between the brand-level and market-level price
elasticity of demand.
8
These quotes are taken from “Congressmen Point to Collusion in Cereal Pricing,” Reuters Limited
(March 7, 1995).
9
A. Nevo, “Measuring Market Power in the Ready-to-Eat Breakfast Cereal Industry,” Econometrica, 69
(March 2001): 307–342.
10
Computation of cereal markups under this scenario requires using oligopoly theory, which you will study
in Chapter 13.
Microeconomia
David A. Besanko, Ronald R. Braeutigam
Copyright © 2009 – The McGraw-Hill Companies srl
430
CHAPTER 11
M O N O P O LY A N D M O N O P S O N Y
median Lerner Index of an individual brand would be
65 to 75 percent. In an industry with competition, the
median Lerner Index of an individual brand would be
40 to 44 percent.
How do these calculations compare to the actual
Lerner Index in the cereal industry? According to Nevo,
the actual Lerner Index for the cereal industry overall in
the mid-1990s was approximately 45 percent. This is far
below the Lerner Index you would expect to see if
Kellogg, General Mills, Post, and Quaker Oats had colluded to fix prices. There is no denying that the Lerner
Index in the cereal industry is positive, indicating that
cereal firms enjoy market power. But the market power
in the cereal industry seems to arise because brands
of cereal are differentiated products, not because of
collusion among manufacturers.
QUANTIFYING MARKET POWER: THE LERNER INDEX
market power The power
of an individual economic
agent to affect the price that
prevails in the market.
Lerner Index of market
power A measure of monopoly power; the percentage markup of price over
marginal cost (P − MC )/P.
11.3
C O M PA R AT I V E
S TAT I C S F O R
MONOPOLISTS
When a firm faces a downward-sloping demand curve, either because it is a monopolist or ( like Coca-Cola) it produces a differentiated product, the firm will have some
control over the market price it sets. For a monopoly, the ability to set the market price
is constrained by competition from substitute products outside the industry. In the case
of differentiated products, a firm’s direct competitors constrain its pricing freedom
(e.g., Pepsi’s price limits the price Coca-Cola can charge).
When a firm can exercise some degree of control over its price in the market, we
say that it has market power.11 Note that perfectly competitive firms do not have
market power. Because perfectly competitive firms produce at the point where price
equals marginal cost, while monopolists or producers of differentiated products will,
in general, charge prices that exceed marginal cost, a natural measure of market power
is the percentage markup of price over marginal cost, (P − MC)/P (the left-hand side
of the IEPR). This measure was suggested by the economist Abba Lerner and is called
the Lerner Index of market power.
The Lerner Index ranges from 0 to 1 (or from 0 to 100 percent). It is zero for a
perfectly competitive industry. It is positive for any industry that departs from perfect
competition. The IEPR tells us that in the equilibrium in a monopoly market, the
Lerner Index will be inversely related to the market price elasticity of demand. As
we’ve discussed, an important driver of the price elasticity of demand is the threat of
substitute products outside the industry. If a monopoly market faces strong competition from substitute products, the Lerner Index can still be low. In other words, a firm
might have a monopoly, but its market power might still be weak.
N
ow that we have explored how the monopolist determines its profit-maximizing quantity and price and the role that the price elasticity of demand plays in that determination,
we are ready to examine how shifts in demand or cost affect the monopolist’s decisions.
SHIFTS IN MARKET DEMAND
Comparative Statics
Figure 11.10 illustrates how a rightward shift in market demand affects the monopolist’s choice of price and quantity. In both panels, we assume that quantity demanded
increases at all market prices (i.e., the original demand curve D0 and the new demand
11
Monopolists and sellers of differentiated products are not the only kinds of firms with market power, as
you will learn in Chapter 13.