Quiz 13: Market Power
Competition is a market structure where many small producers sell a standardized product to many small buyers. A competitive market has three characteristics: • Many small buyers and sellers; so no one can charge a higher price. If any seller dos that the buyers will buy the product from anyone else. • A standardized product; means all products are roughly the same. The buyer will not consider from whom she is buying. • No barriers to entry; anybody can enter or exit the market to sell the product. In real world there are many such market exist, the larger one being the market for agricultural product. The other examples are, printing industry, stationary products, apparel manufacturing etc.
Market power is defined as the ability of an individual firm to influence the market price of its product. The price can be increase by decreasing the quantity of the firm's supply. The reduction in supply can be done in accordance with the demand for product in the market. If there are barriers to entry in these markets, the markets may be dominated by one or few firms; usually they have the market power to influence the price. The implications of market power to the society are sometimes inefficient. Some of the consequences of market power are: • The market power leads to underproduction, higher prices, supernormal profits and also collusion, inefficiency and price discrimination. • The market power in the economy often leads to collusion; which is simply price fixing. Every existing firm cooperates with each other to restrict the supply in the market thereby raising the price of the product. • Another problem with the market power is it leads to inefficiency and wastage. The firm which dominates the industry does not have much incentive to be efficient on cutting unnecessary cost. As there are barriers to entry, they continue to waste the scarce resources on advertising and differentiating. • Market power also leads to price discrimination that is charging different groups with different price though there is no difference in cost.
Some markets are dominated by only few firms because there are barriers to entry in these markets. The barriers to entry prevent a new firm from entering the market. Price cutting is a way to put barriers to entry. Firms to deter entry into the market often use barriers to entry. So the firms wanting to enter the market have difficulty to enter the market. As large firm operates at economies of scale, they can produce large quantity at lower costs. But this is not possible for the new firms. So, they keep themselves off from the industry. The barriers to entry works as a guard which protects the old firm from competition outside.