Measuring the Monopoly Power (3 Methods)

Different measures that have been suggested are as follows:

1. Concentration Ratio:

Concentration ratio refers to the fraction of total market sales controlled by the largest group of sellers.

The inclusion of the market shares of several firms in the concentration ratio rests upon the possibility that large firms will adopt a common price- output policy which may not be very different from the one they would adopt if they were under unified management.

But here difficulty arises that they may not do so. Therefore, a high concentration ratio may be necessary for the exercise of monopoly power but it is not sufficient.

2. Profit-Rate as a Measure:

J.S. Bain used profit-rate as a measure of monopoly power. By high profits, economists mean returns sufficiently in excess of all opportunity costs which potential new entrants desire for entering the industry.

The size of super-normal profits which a firm is able to earn is an indication of its monopoly power. In perfect competition, a firm earns only normal profits. In monopoly, new entrants will not normally compete away monopoly profits. But there will be some level of profits at which new firms will find it worth taking the risk of trying to break the monopoly.

The stronger the monopolists position, the greater the profits he will be able to earn without attracting new rivals. In short, it is said that neither concentration ratio nor profit-rate are ideal measures of the degree of monopoly power, both are of some value nor both are widely used.

3. Lerner’s Measure:

It is the oldest measure and is based on the difference between the price charged by the monopolist and his marginal cost. Bober gives the formula 1/E. Thus, degree of monopoly power varies inversely with the elasticity of demand for the commodity.

However, the more commonly used formula is:

Degree of monopoly power = (P-MC) / P

Where P is price charged by the monopolist and MC his marginal cost.

In perfect competition,

P = MC and the formula (P-MC)/P  gives zero answer indicating no monopoly power. If the monopolized product is a free good, MC = 0 and the formula registers unity. The index of monopoly power thus varies from zero to unity. Since monopolized goods are seldom free, monopoly power is seldom as high as unity.

This method is not free from defects as:

(i) Firstly it does not measure non-price competition. Secondly, monopoly power is shown itself not only in high price but also in output restriction. Output may be restricted by under-utilization of capacity already in existence or by restricting new entry.

(ii) Lerner’s method throws no light on these aspects of monopoly power.