In the study of economics, market power is the ability of individual firms to exert control over the price of goods, raising them above the perfectly competitive price. The fewer number of firms that operate in the market, the more market power an individual firm will have due to its lack of competitors. Companies like Microsoft or De Beers are most commonly cited as examples of monopolies operating with extreme market power, but the concept is not strictly limited to monopolistic markets. In fact, since the requirements for perfect competition can never actually be met in reality (namely, the one requiring an arbitrarily infinite number of producer firms), all existing markets demonstrate some degree of market power in firm behavior— each firm has the capacity (however miniscule) to charge above the perfectly competitive price.
So why should we care about market power? Because you’re getting ripped off, and it happens every time you make a market transaction. In economics, perfect competition is the base model for efficiency, and the equilibrium price accurately reflects what the consumer is “supposed” to pay, and what the producer is “supposed” to charge. But, there’s no capacity for profit in perfect competition— firms have to charge where marginal revenue equals marginal cost, so they even out in the end. Under conditions of market power, however, a firm’s artificial elevation of price and voluntary limitation of production results in consumers paying more and receiving less. The study of market power is thus primarily concerned with how much economic inefficiency we’re willing to put up with.
A little bit of terminology before we continue (feel free to throw these out at your next dinner party if you want to sound sophisticated):
- Duopoly: a market controlled by two firms
- Oligopoly: a market controlled by multiple firms
- Predatory pricing: also called “price cutting”, when firms deliberately lower their prices to eliminate their competitors. Short term loss, long term benefit. De Beers, mentioned above, is notorious for this, as they often flood the market with stockpiled diamonds whenever a rival diamond distributor doesn’t cooperate. This is actually mild compared to their other shady business practices.
- Collusion: when firms cooperate with each other, coordinating price changes in order to increase profits. A background in game theory is really helpful for understanding collusion, but that’s for another node.
Why do we put up with market power at all, if we’re getting ripped off? Because in some situations, monopolies are actually desirable. A natural monopoly is an industry that experiences increased social costs as more producers enter the market, and is thus “naturally” suited to be a monopoly. Examples typically include public transportation and utilities, since standardization of the infrastructure is a necessity to the operation of the market— trains can’t run on different sized tracks, and water pipes need to match up in order to work. An argument can be made that Microsoft’s dominance over the computer market, unscrupulous as it is, is actually a necessity given the difficulties with cross-platform compatibility. The public usually puts up with natural monopolies because any alternative would result in a collapse of the market, and no good provision at all. Government intervention is often a remedy for the more harmful effects of natural monopolies, with Big Brother supporting the producer in order to ensure that consumers pay reasonably lower prices without forcing the firm to go out of business.