Market Power
Market power is the ability of a firm or group of firms to raise prices above the competitive level, or to reduce output, quality, or other dimensions of competition, without losing all their customers to rivals. A firm with market power faces a downward-sloping demand curve, so that it can influence the price it receives, in contrast to a firm in perfect competition, which takes the market price as given. Market power arises from various sources, has consequences for efficiency and welfare, and is subject to competition policy.
Sources
Market power arises from barriers to entry and from the structure of the market. Where the number of firms is small, each firm has more latitude to raise prices, because rivals cannot easily expand or enter. Product differentiation, which makes products imperfect substitutes, reduces the elasticity of demand facing each firm and gives it pricing power. Control of essential inputs, patents, and other legal protections can create market power.
Economies of scale can create market power by making it difficult for new firms to enter at a competitive scale. Network effects, in which the value of a product increases with the number of users, can entrench incumbents and raise barriers to entry. Switching costs, which make it costly for customers to change suppliers, and access to data, which can confer an advantage in serving customers, are increasingly important sources of market power in digital markets.
Measurement
Market power is measured in several ways. The mark-up of price over marginal cost measures the extent to which prices exceed competitive levels, and it is the direct indicator of market power. Measures of concentration, such as the share of the largest firms or indices of concentration, are used as proxies, on the assumption that concentrated markets are more conducive to market power, although concentration does not always imply market power.
The elasticity of demand facing a firm determines its market power: the less elastic the demand, the greater the power to raise price. Cross elasticities with rival products, and the closeness of substitutes, therefore matter. In practice, competition authorities examine evidence on pricing, on margins, on the behaviour of demand in response to price changes, and on barriers to entry, rather than relying on a single measure.
Consequences
Market power has several consequences. It raises prices and restricts output relative to the competitive outcome, reducing consumer surplus and creating deadweight loss. It can reduce incentives to invest in efficiency and quality, because firms face less competitive pressure. It can distort the distribution of income, transferring resources from consumers to firms, and it can slow innovation, although in some circumstances market power may support innovation by allowing firms to capture the returns on research.
Market power also has implications for macroeconomic performance. Widespread market power can raise the mark-up and reduce the share of income going to labour, contributing to inequality. It can raise prices and contribute to inflation, and it can reduce the responsiveness of prices to demand, affecting the transmission of monetary policy. The measurement and control of market power are therefore of interest beyond competition policy.
Competition policy
Competition policy seeks to limit the acquisition and exercise of market power. Merger control prevents transactions that would substantially lessen competition, and prohibitions on anti-competitive agreements prevent firms from coordinating to raise prices or to divide markets. Rules on abuse of dominance prevent firms with market power from engaging in conduct that excludes rivals or exploits customers, such as predatory pricing, exclusive dealing, and refusal to supply.
Regulation addresses market power in industries where competition is not feasible, such as utilities and networks. Price regulation, access requirements, and structural separation are used to constrain the exercise of market power and to protect consumers. The design of regulation must balance the objective of constraining market power against the need to preserve incentives for investment and efficiency.
Dynamic considerations
Market power has dynamic as well as static effects. On the one hand, firms with market power may have less incentive to innovate, because they face less competitive pressure and because they can protect their position. On the other hand, the prospect of earning returns above the competitive level provides the incentive to invest in research and development, and patents and other protections are justified on this basis. The relationship between market power and innovation is therefore complex and depends on the nature of competition and on the institutional environment.
In network industries and in digital markets, dynamic considerations are especially important. Network effects and data advantages can entrench incumbents, and the risk of tipping, in which a market comes to be dominated by a single firm, raises concerns about the persistence of market power and its effects on innovation. Competition policy in these markets must balance the static benefits of scale and integration against the dynamic risks of entrenched dominance.
Market power and macroeconomic performance
Market power affects macroeconomic outcomes as well as competition in individual markets. Widespread market power can raise mark-ups and reduce the responsiveness of prices to changes in demand, affecting the transmission of monetary policy. It can reduce the share of income going to labour, contributing to inequality and to changes in the distribution of income between capital and labour. It can also affect investment, since firms with market power may invest less or in different ways than competitive firms.
These macroeconomic effects have attracted increasing attention. Research on the rise of mark-ups and on the decline of the labour share has identified market power as one of several contributing factors, alongside technology and globalisation. The measurement of market power at the economy-wide level, and its implications for inflation, employment, and growth, are active areas of research, and they link competition policy to the broader analysis of macroeconomic performance.
Remedies and their effects
Remedies for market power depend on its source. Where market power arises from a merger, structural remedies may require divestiture, and behavioural remedies may impose conditions on conduct. Where it arises from anti-competitive agreements, prohibitions and fines are used to deter and to punish. Where it arises from the structure of the market, regulation may be needed to constrain prices or to require access to essential facilities.
The design of remedies must consider their effects on incentives and on efficiency. Structural remedies can restore competition but may sacrifice economies of scale, while behavioural remedies preserve the firm's structure but require ongoing monitoring. In digital markets, where remedies are uncertain, regulators have experimented with interoperability requirements, data portability, and restrictions on self-preferencing, aiming to lower barriers to entry without destroying the benefits of the incumbent's investments.