How do you measure market power and failure?

1 Market Power Index

One way to measure market power is to use the market power index (MPI), which is the ratio of the actual price to the marginal cost of production. The marginal cost is the additional cost of producing one more unit of output. The MPI indicates how much a firm can mark up its price above its cost, which reflects its degree of market power. A higher MPI means a higher degree of market power and vice versa. The MPI can be calculated using the formula: MPI = (P - MC) / P where P is the price and MC is the marginal cost. The MPI ranges from zero to one, where zero means perfect competition and one means monopoly.

2 Herfindahl-Hirschman Index

Another way to measure market power is to use the Herfindahl-Hirschman index (HHI), which is the sum of the squared market shares of all the firms in a market. The market share is the percentage of the total sales or output of a firm in a market. The HHI indicates how concentrated or competitive a market is, which affects the degree of market power of the firms. A higher HHI means a higher degree of market concentration and market power and vice versa. The HHI can be calculated using the formula: HHI = s1^2 + s2^2 + ... + sn^2 where s1, s2, ..., sn are the market shares of the n firms in a market. The HHI ranges from zero to 10,000, where zero means perfect competition and 10,000 means monopoly.

3 Deadweight Loss

One way to measure market failure is to use the deadweight loss (DWL), which is the loss of economic surplus or welfare due to the deviation of the market outcome from the optimal or efficient outcome. The economic surplus is the sum of the consumer surplus and the producer surplus, which are the benefits that consumers and producers gain from trading in a market. The optimal or efficient outcome is the one where the marginal benefit equals the marginal cost, which maximizes the economic surplus. The DWL indicates how much economic surplus is wasted or foregone due to the market failure, which reduces the social welfare. The DWL can be calculated using the formula: DWL = 0.5 x (Q* - Q) x (P* - P) where Q* is the optimal or efficient quantity, Q is the actual quantity, P* is the optimal or efficient price, and P is the actual price. The DWL is the area of the triangle formed by the demand curve, the supply curve, and the actual quantity.

4 Social Cost and Benefit

Another way to measure market failure is to use the social cost and benefit, which are the total costs and benefits of an activity or a product or service to the society, including both the private and the external costs and benefits. The private costs and benefits are the costs and benefits that are borne or received by the individuals or firms involved in the activity or the product or service. The external costs and benefits are the costs and benefits that are imposed or conferred on others who are not involved in the activity or the product or service. The social cost and benefit indicate how much an activity or a product or service affects the social welfare, which may differ from the private welfare. The social cost and benefit can be calculated using the formula: Social Cost = Private Cost + External Cost Social Benefit = Private Benefit + External Benefit

5 Here’s what else to consider

This is a space to share examples, stories, or insights that don’t fit into any of the previous sections. What else would you like to add?