Market power

Competition law
Basic concepts
Anti-competitive practices
Enforcement authorities and organizations

In economics, market power refers to the ability of a firm to influence the price at which it sells a product or service by manipulating either the supply or demand of the product or service to increase economic profit.[1] In other words, market power occurs if a firm does not face a perfectly elastic demand curve and can set its price (P) above marginal cost (MC) without losing revenue.[2] This indicates that the magnitude of market power is associated with the gap between P and MC at a firm's profit maximising level of output. The size of the gap, which encapsulates the firm's level of market dominance, is determined by the residual demand curve's form. A steeper reverse demand indicates higher earnings and more dominance in the market.[2] Such propensities contradict perfectly competitive markets, where market participants have no market power, P = MC and firms earn zero economic profit.[3] Market participants in perfectly competitive markets are consequently referred to as 'price takers', whereas market participants that exhibit market power are referred to as 'price makers' or 'price setters'.

The market power of any individual firm is controlled by multiple factors, including but not limited to, their size, the structure of the market they are involved in, and the barriers to entry for the particular market. A firm with market power has the ability to individually affect either the total quantity or price in the market. This said, market power has been seen to exert more upward pressure on prices due to effects relating to Nash equilibria and profitable deviations that can be made by raising prices.[4] Price makers face a downward-sloping demand curve and as a result, price increases lead to a lower quantity demanded. The decrease in supply creates an economic deadweight loss (DWL) and a decline in consumer surplus.[5] This is viewed as socially undesirable and has implications for welfare and resource allocation as larger firms with high markups negatively effect labour markets by providing lower wages.[5] Perfectly competitive markets do not exhibit such issues as firms set prices that reflect costs, which is to the benefit of the customer. As a result, many countries have antitrust 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.

Market power provides firms with the ability to engage in unilateral anti-competitive behavior.[6] As a result, legislation recognises that firms with market power can, in some circumstances, damage the competitive process. In particular, firms with market power are accused of limit pricing, predatory pricing, holding excess capacity and strategic bundling.[7] A firm usually has market power by having a high market share although this alone is not sufficient to establish the possession of significant market power. This is because highly concentrated markets may be contestable if there are no barriers to entry or exit. Invariably, this limits the incumbent firm's ability to raise its price above competitive levels.

If no individual participant in the market has significant market power, anti-competitive conduct can only take place through collusion, or the exercise of a group of participants' collective market power.[4] An example of which was seen in 2007, when British Airways was found to have colluded with Virgin Atlantic between 2004 and 2006, increasing their surcharges per ticket from £5 to £60.[8]

Regulators are able to assess the level of market power and dominance a firm has and measure competition through the use of several tools and indicators. Although market power is extremely difficult to measure, through the use of widely used analytical techniques such as concentration ratios, the Herfindahl-Hirschman index and the Lerner index, regulators are able to oversee and attempt to restore market competitiveness.[9]

  1. ^ Landes, William M.; Posner, Richard A. (1981). "Market Power in Antitrust Cases". Harvard Law Review. 94 (5): 937–996. doi:10.2307/1340687. JSTOR 1340687.
  2. ^ a b Syverson, Chad (2019). "Macroeconomics and Market Power: Context, Implications, and Open Questions". Journal of Economic Perspectives. 33 (3): 23–43. doi:10.1257/jep.33.3.23. S2CID 201326865.
  3. ^ Pleatsikas, Christopher (2018). "Perfect Competition". The Palgrave Encyclopedia of Strategic Management. pp. 1272–1275. doi:10.1057/978-1-137-00772-8_558. ISBN 978-0-230-53721-7.
  4. ^ a b Davis, Douglas D. (2018). "Market Power and Collusion in Laboratory Markets". The New Palgrave Dictionary of Economics. pp. 8260–8263. doi:10.1057/978-1-349-95189-5_2836. ISBN 978-1-349-95188-8.
  5. ^ a b Unger, Gabriel; Eeckhout, Jan; De Loecker, Jan (2020). "The Rise of Market Power and the Macroeconomic Implications". The Quarterly Journal of Economics. 135 (2): 561–644. doi:10.1093/qje/qjz041.
  6. ^ Vatiero, Massimiliano (2010). "The Ordoliberal Notion of Market Power: An Institutionalist Reassessment". European Competition Journal. 6 (3): 689–707. doi:10.5235/ecj.v6n3.689. S2CID 154973650.
  7. ^ Leslie, C. (2013). PREDATORY PRICING AND RECOUPMENT. Columbia Law Review, 113(7), 1695–1771.
  8. ^ Lin, Jing; Ma, Xin; Talluri, Srinivas; Yang, Cheng-Hu (2021-02-09). "Retail channel management decisions under collusion". European Journal of Operational Research. 294 (2): 700–710. doi:10.1016/j.ejor.2021.01.046. ISSN 0377-2217.
  9. ^ Borenstein, Severin; Bushnell, James; Knittel, Christopher R. (1999). "Market Power in Electricity Markets: Beyond Concentration Measures". The Energy Journal. 20 (4): 65–88. doi:10.5547/ISSN0195-6574-EJ-Vol20-No4-3. ISSN 0195-6574. JSTOR 41326187.