Market power

Definition

Market power is the ability of a firm or group of firms to influence the price of a product or service in the market. This power arises when a seller or a group of sellers has a significant control over supply, which can lead to higher prices, reduced output, and less competition. Firms with market power often engage in strategies such as product differentiation and controlling market entry to maintain their advantageous position.

5 Must Know Facts For Your Next Test

1. Market power is often measured using the Lerner Index, which indicates the price markup over marginal cost.
2. Firms with market power can sustain profits in the long run, unlike firms in perfectly competitive markets where profits tend to normalize.
3. Product differentiation is a common strategy used by firms to create a perception of uniqueness, allowing them to gain more market power.
4. In an oligopoly, firms may exhibit collusive behavior to maintain their market power, leading to higher prices for consumers.
5. The degree of market power can be influenced by factors such as barriers to entry, brand loyalty, and the availability of substitutes.

Review Questions

• How does product differentiation affect a firm's market power?
  • Product differentiation enhances a firm's market power by creating unique features or perceived value that distinguish its products from competitors. When consumers perceive these products as different or superior, they become less sensitive to price changes, allowing the firm to charge higher prices. This ability to attract and retain customers based on unique attributes strengthens the firm's overall position in the market.
• Discuss the implications of market power on consumer welfare and competition within an industry.
  • Market power can negatively impact consumer welfare by leading to higher prices and reduced choices. When firms with significant market power set prices above competitive levels, consumers end up paying more than they would in a competitive environment. Additionally, such power can stifle competition by creating barriers for new entrants, reducing innovation and limiting overall market efficiency.
• Evaluate the role of barriers to entry in maintaining a firm's market power and discuss potential policy responses.
  • Barriers to entry play a crucial role in maintaining a firm's market power by preventing new competitors from entering the market easily. High startup costs, regulatory hurdles, and established brand loyalty can deter potential entrants, allowing incumbent firms to sustain their pricing strategies and profit margins. Policymakers may respond to this by implementing antitrust regulations aimed at reducing these barriers, promoting competition and protecting consumer interests through measures such as breaking up monopolies or preventing anti-competitive practices.

Related terms

Monopoly: A market structure where a single seller dominates the market, allowing them to set prices above competitive levels.

Oligopoly: A market structure characterized by a small number of firms that have significant market power, often leading to interdependent pricing and output decisions.

Price Discrimination: A pricing strategy where a firm charges different prices to different customers for the same product, based on their willingness to pay.