Using Empirical Marginal Cost to Measure Market Power in the US Economy

Tuesday, November 6, 2018

Economics Working Paper 18118

Abstract: Market power arises in the case where a seller is aware that raising output will depress price. In the profit-maximizing equilibrium with market power, price exceeds marginal cost. The Lerner index—the ratio of price less marginal cost to the price—is a widely accepted measure of market power. Measuring marginal cost is a challenge. This paper develops and applies a direct empirical approach—marginal cost is measured as the ratio of the observed change in cost to the observed change in output. Because marginal cost is a partial derivative, both changes need to be adjusted for other sources of change. Thus marginal cost is the ratio of (1) the change in cost not associated with changes in input prices to (2) the change in output not associated with productivity change. I develop data for the 60 KLEMS industries for this measure. I find a typical Lerner index of 0.15. Lerner indexes grew moderately between 1988 and 2015.

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