How this calculator works
The Lerner index compares price with marginal cost. A firm that prices exactly at marginal cost has an index of zero, while a higher index means a larger gap between what buyers pay and what the extra unit costs to produce. The index sits between zero and one for a profit-maximising firm with a downward-sloping demand curve. A negative index means the price is below marginal cost, which happens with loss leaders, price wars or regulated pricing. For a profit-maximising monopolist the index also equals the negative reciprocal of the price elasticity of demand, so weaker competition and less elastic demand both raise it.
Formula
L = (P - MC) / P, where P is price and MC is marginal cost. Rearranged, P = MC / (1 - L) and MC = P x (1 - L). The markup over marginal cost is (P - MC) / MC. At a profit maximum, L = -1 / E, where E is the price elasticity of demand, a negative number.
Worked example
A price of $200 with a marginal cost of $120 gives L = (200 - 120) / 200 = 0.4, and a markup of 66.67% over marginal cost. A firm that wants an index of 0.25 while facing a marginal cost of $100 must charge $100 / (1 - 0.25) = $133.33. At a price of $80 and an index of 0.3, marginal cost is $80 x 0.7 = $56.
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Frequently asked questions
What counts as marginal cost?
Use the cost of producing one additional unit, including materials and the extra labour or energy it requires. Average total cost includes fixed costs that do not change with output, so using it understates market power.
Can the index be above one?
Not with a positive price and nonnegative marginal cost. Above one would require marginal cost to be negative. Values that large usually mean the inputs are mismatched or a cost was entered with the wrong sign.
Is a high Lerner index illegal?
The index is an economic measure, not a legal test. Competition authorities look at market definition, barriers to entry and conduct. A high index can also come from a temporary innovation or a differentiated product, so it is evidence to examine rather than proof of abuse.