Market power

Definition

Market power is the ability of a firm or group of firms to influence the price of a good or service in the market. It reflects the degree of control a seller has over the market, allowing them to set prices above the competitive level, which can lead to higher profits. Market power varies across different market structures, impacting pricing strategies, competition, and consumer choices.

5 Must Know Facts For Your Next Test

1. In perfectly competitive markets, firms have no market power because they are price takers and cannot influence market prices.
2. Monopolies have significant market power since they are the sole provider of a good or service, allowing them to set prices without competition.
3. Oligopolistic markets exhibit interdependent pricing, where firms must consider competitors' reactions when exercising their market power.
4. Firms with market power can engage in price discrimination, charging different prices to different consumers based on their willingness to pay.
5. Market power can lead to inefficiencies in the economy, such as deadweight loss, due to reduced output compared to competitive levels.

Review Questions

• How does market power differ between perfectly competitive markets and monopolistic markets?
  • In perfectly competitive markets, individual firms have no market power; they are price takers and must accept the prevailing market price. In contrast, monopolistic markets allow a single firm to hold significant market power, enabling it to set prices above marginal costs without losing customers. This difference in market power results in varying effects on consumer choice and overall welfare.
• Discuss how barriers to entry impact the level of market power in an oligopoly compared to a monopoly.
  • Barriers to entry play a crucial role in determining market power in both oligopolies and monopolies. In monopolies, high barriers prevent any competition from entering the market, allowing the single provider to maintain substantial pricing control. In oligopolies, while barriers may still be present, multiple firms can exert collective market power. However, the presence of competitors means that individual firms must consider rival pricing and strategies when exercising their market power.
• Evaluate the implications of market power on consumer welfare and economic efficiency.
  • Market power can lead to reduced consumer welfare and economic inefficiency through practices like higher prices and decreased output. When firms with significant market power raise prices above competitive levels, consumers face limited choices and may pay more than what would prevail in a competitive environment. This situation often results in deadweight loss—where potential gains from trade are not realized—leading to an overall decline in economic efficiency and leaving consumers worse off than they would be under perfect competition.

Related terms

Price Maker: A firm that has the ability to set the price of its product instead of taking the market price as given, typically found in monopolistic and oligopolistic markets.

Elasticity of Demand: The measure of how much the quantity demanded of a good responds to changes in price, affecting a firm's ability to raise prices without losing sales.

Barriers to Entry: Obstacles that make it difficult for new firms to enter a market, which can enhance the market power of existing firms by limiting competition.