Managerial Economics

Market power & its

sources, conjectural
Variations
[Type the document subtitle]
Apurva Sharma
[Pick the date]

Introduction
A company's ability to manipulate price by influencing an item's supply, demand or both. A
company with market power would be able to affect price to its benefit. Firms with market
power are said to be "price makers" as they are able to set the price for an item while
maintaining market share. Generally, market power refers to the amount of influence that a
firm has on the industry in which it operates.
Market power is the ability of a firm to profitably raise the market price of a good or service
over marginal cost. In perfectly competitive markets, market participants have no market
power. A firm with total market power can raise prices without losing any customers to
competitors. Market participants that have market power are therefore sometimes referred
to as "price makers," while those without are sometimes called "price takers." Significant
market power is when prices exceed marginal cost and long run average cost, so the firm
makes economic profits.
A firm with market power has the ability to individually affect either the total quantity or
the prevailing price in the market. Price makers face a downward-sloping demand curve,
such that price increases lead to a lower quantity demanded. The decrease in supply as a
result of the exercise of market power creates an economic deadweight loss which is often
viewed as socially undesirable. As a result, many countries have anti-trust or other
legislation intended to limit the ability of firms to accrue market power. Such legislation
often regulates mergers and sometimes introduces a judicial power to compel divestiture.
A firm usually has market power by virtue of controlling a large portion of the market. In
extreme cases - monopoly and monopsony - the firm controls the entire market. However,
market size alone is not the only indicator of market power. Highly concentrated
markets may be contestable if there are no barriers to entry or exit, limiting the incumbent
firm's ability to raise its price above competitive levels.
Market power gives firms the ability to engage in unilateral anti-competitive
behaviour. Some of the behaviours that firms with market power are accused of engaging in
include predatory pricing, product tying, and creation of overcapacity or other barriers to
entry. If no individual participant in the market has significant market power, then anti-
competitive behaviour can take place only through collusion, or the exercise of a group of
participants' collective market power.
MARKET STRUCTURE
Perfect competition: When there are many firms that are small relative to
the entire market and produce similar products
Firms are price takers.
Products are standardized (identical).
There are no barriers to entry.
There is no nonprice competition.

Imperfect competition
Firms have some degree of market power and can determine prices strategically.
Products may not be standardized.
Firms employ nonprice competition.
Product differentiation
Advertising
Branding
Public relations

Monopolistic competition: When there are many firms and consumers, just as in perfect
competition; however, each firm produces a product that is slightly different from the products
produced by the other firms.
There are no barriers to entry.
Monopoly:
Markets with a single seller
Barriers to entry prevent competitors from entering the market.
Monopoly power is an example of market failure which occurs when one or more of the
participants has the ability to influence the price or other outcomes in some general or
specialized market. The most commonly discussed form of market power is that of
a monopoly, but other forms such as monopsony, and more moderate versions of these
two extremes, exist.

A well-known example of monopolistic market power is Microsoft's market share
in PC operating systems. The United States v. Microsoft case dealt with an allegation that
Microsoft illegally exercised its market power by bundling its web browser with its
operating system. In this respect, the notion of dominance and dominant position in EU
Antitrust Law is a strictly related aspect.
[

Oligopoly:
Markets with a few sellers
There are significant barriers to entry

When several firms control a significant share of market sales, the resulting market
structure is called an oligopoly . An oligopoly may engage in collusion, either tacit or overt,
and thereby exercise market power. An explicit agreement in an oligopoly to affect market
price or output is called a cartel.

Sources of Market power:
A monopoly can raise prices and retain customers because the monopoly has no
competitors. If a customer has no other place to go to obtain the goods or services, they
either pay the increased price or do without. Thus the key to market power is to preclude
competition through high barriers of entry. Barriers to entry those are significant sources of
market power are control of scarce resources, increasing returns to scale, technological
superiority and government created barriers to entry. OPEC is an example of an organization
that has market power due to control over scarce resources - oil. Increasing returns to scale
are another important source of market power. Firms experiencing increasing returns to
scale are also experiencing decreasing average total costs.
[5]
Firms in such industries become
more profitable with size.
[6]
Therefore over time the industry is dominated by a few large
firms. This dominance makes it difficult for start up firms to succeed.
[7]
Firms like power
companies, cable television companies and wireless communication companies with large
start up costs fall within this category. A company wishing to enter such industries must
have the financial ability to spend millions of dollars before starting operations and
generating any revenue.
[8]
Similarly established firms also have a competitive advantage
over new firms. An established firm threatened by a new competitor can lower prices to
drive out the competition. Microsoft is a firm that has substantial pricing or market power
due to technological superiority in its design and production processes.
[9]
Finally
government created barriers to entry can be a source of market power. A prime example
are patents granted to pharmaceutical companies. These patents give the drug companies a
virtual monopoly in the protected product for the term of the patent.