💪 What Is Market Power?
Definition: Market power.
In a perfectly competitive market, no single firm can affect the price. But when firms have market power, they can raise prices above the competitive level, restrict output, and earn abnormal (supernormal) profits in the long run.
Sources of market power
- High market concentration — few firms control most of the market (oligopoly or monopoly).
- Product differentiation — firms make their product seem unique through branding, quality, or features.
- Control of essential resources — owning a key input gives dominance (e.g. De Beers and diamonds).
- Legal barriers — patents, copyrights, and licences grant exclusive rights.
🚧 Barriers to Entry
Definition: Barriers to entry.
Types of barriers
- Economies of scale — the incumbent produces at such low average cost that new entrants can't compete (a 'natural' barrier).
- High start-up costs — industries like aerospace, telecoms, or pharmaceuticals need enormous initial investment.
- Legal barriers — patents protect inventions for 20 years; government licences restrict who can operate (e.g. broadcasting).
- Brand loyalty — consumers are locked in to established brands, making it hard for newcomers to attract customers.
- Control of supply chains — owning distribution networks or key inputs locks competitors out.
- Predatory pricing — incumbents temporarily cut prices below cost to drive entrants out, then raise prices again.
Barriers to entry explain why market power persists. Without barriers, supernormal profits would attract new firms → competition → profits return to normal. Barriers are what keep this from happening.
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📉 Market Power and Inefficiency
A firm with market power maximises profit by producing where MR = MC. Unlike a competitive firm, this means restricting output below the competitive level and charging a higher price.
Why this is market failure
- Allocative inefficiency — price > MC, so the last unit consumed is valued more than it costs to produce. Resources are under-allocated to this market.
- Deadweight loss.
- Reduced consumer surplus — higher prices transfer surplus from consumers to the firm.
- Possible productive inefficiency — without competitive pressure, firms may not minimise costs (X-inefficiency).
In diagrams: the competitive outcome is where D = MC. The monopoly outcome is where MR = MC, with price read off the demand curve. The triangle between these two points is the deadweight loss.