Market Power

Definition

Market power refers to the ability of a firm or group of firms to influence the price, quantity, or quality of a good or service in a market. It is a key concept in understanding the dynamics of competition and the potential for anti-competitive behavior in various industries.

5 Must Know Facts For Your Next Test

1. Market power allows firms to charge higher prices, restrict output, and reduce product quality or variety, often at the expense of consumer welfare.
2. The degree of market power possessed by a firm is often measured by its market share and the ease with which new competitors can enter the market.
3. Antitrust laws, such as the Sherman Act and the Clayton Act, are designed to promote competition and limit the abuse of market power by dominant firms.
4. Mergers and acquisitions can increase market concentration and lead to greater market power, which may be scrutinized by antitrust authorities.
5. Firms with significant market power may engage in exclusionary practices, such as predatory pricing or refusal to deal, to maintain their dominance.

Review Questions

• Explain how market power can affect the pricing and output decisions of firms.
  • Firms with significant market power can use their influence to set higher prices and restrict output, often at the expense of consumer welfare. This is because they face less competitive pressure and can exploit their position to maximize profits. In contrast, firms in highly competitive markets have little to no market power and must accept the prevailing market price and produce at the level where price equals marginal cost.
• Describe the role of antitrust laws in addressing the potential abuse of market power.
  • Antitrust laws, such as the Sherman Act and the Clayton Act, are designed to promote competition and limit the abuse of market power by dominant firms. These laws prohibit anti-competitive practices, such as mergers and acquisitions that significantly increase market concentration, as well as exclusionary tactics like predatory pricing and refusal to deal. By enforcing these laws, antitrust authorities aim to protect consumers from the negative effects of market power and ensure a more competitive marketplace.
• Analyze how the presence of barriers to entry can contribute to the maintenance of market power.
  • Barriers to entry, such as economies of scale, high capital requirements, or government regulations, can make it difficult for new firms to enter a market and challenge the dominance of incumbent firms. This allows the incumbent firms to maintain their market power, as they face less competitive pressure. Firms with significant market power may also actively work to erect or preserve these barriers, further entrenching their position and limiting the ability of new competitors to emerge. The presence of high barriers to entry is a key factor in determining the degree of market power held by firms in a particular industry.

Related terms

Monopoly: A market structure in which a single firm is the sole producer and seller of a good or service, giving it significant market power.

Oligopoly: A market structure in which a small number of firms dominate the production and sale of a good or service, allowing them to collectively exercise market power.

Barriers to Entry: Factors that make it difficult for new firms to enter a market, enabling incumbent firms to maintain their market power.