Market Power and Market Definition

• The definition of a market is relatively subjective, which means market power is prone to errors
• We need a realistic market definition; however, the Lerner index has a self-correcting mechanism

\[ \lambda = \frac{S}{|\eta|+\varepsilon(1-S)} \]

• Thought Exercise 1
  • Suppose the market is too narrowly defined
  • This means there will be an upward bias on a firm’s market share
  • However, observed price elasticity of total market demand will be higher (consumers are more likely to switch)
• Thought Exercise 2
  • Suppose the market is too broadly defined
  • This means there will be a downward bias on a firm’s market share
  • However, observed price elasticity will be lower