What Is Market Power (Explained: All You Need To Know)

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What is Market Power?

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What Is Market Power

Market power refers to a company’s ability to raise and maintain prices above the level expected in a competitive market.

In other words, when a company has a lot of market power, it will have the power to dictate terms and conditions that would not have been possible in a competitive market.

In essence, “market power” is a company’s ability to manipulate prices in the marketplace by manipulating supply, demand, or both.

Very often, companies that exercise significant market power are able to significantly increase the price of their products and services without losing market share.

This is the case as the company may have significant control over supply or demand and has the ability to prevent new players from entering the market.

In a competitive market, when a company raises prices, it will naturally lose market share as its customers will move to a competitor offering a similar product or service at a better price.

However, when a company has excessive market power, it will have the ability to control prices forcing its customers to pay the established rate knowing the customers do not have a meaningful alternative option.

Keep reading as I will further break down the meaning of market power and tell you how it works.

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Why Is Market Power Important

Companies and company leaders should understand the concept of market power to avoid unintended consequences.

In general, market power refers to a company’s ability to dictate prices in a particular market without losing market share.

For example, if there is only one company that produces a particular type of goods, consumers will have no choice but to purchase from this company as there are no alternative options in the market.

In this scenario, the company can potentially increase prices and maintain them at high levels to maximize profit without losing market share.

When companies have enough power to dictate prices, we call them price makers as customers have no choice but to pay what the company sets in prices.

On the other hand, if the market is highly competitive, then companies will be price takers as they have no choice but to accept what customers are willing to pay.

Companies that exercise excessive market power or abuse of dominance can be heavily scrutinized by the government and potentially face antitrust lawsuits.

If you are considering a merger or acquisition within an industry that can result in significant market power for the post-transaction entity, it’s likely that the government will not approve such a transaction.

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Types of Market Power

You can categorize market power into three broad categories.

The first type of market power is a monopoly.

A company having a monopoly in an industry or market is essentially a company that fully dominates the market or a significant portion of the market.

A monopoly can set prices and impose terms and conditions that the market will have no choice but to accept.

In markets dominated by a monopoly, you have little to no competition and market prices are dictated by one company, not the market.

The second type of market power is when there’s perfect competition and no single company is able to exercise any meaningful control on demand or supply.

In a market with perfect competition, you have many rival companies offering similar products and services and there are little to no barriers to entry for new competitors.

In a perfectly competitive market, consumers can easily go from one vendor to another and get more favorable prices.

A third type of market power is an oligopoly.

An oligopoly refers to a market where a few companies exercise dominance.

In a market where several companies dominate, other competitors will have a difficult time penetrating the market due to the oligopoly’s dominance.

However, the companies forming the oligopoly do not individually exercise substantial control in the market.

Rather, the oligopoly’s dominance comes from the dominating players setting market prices.

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Market Power Sources

There are different factors that can affect how a company achieves market power.

The first source of market power is the number of competitors competing in the space.

The fewer the number of companies competing in the space, the more market power the existing players can have.

Another factor is the elasticity of demand.

If the demand for a company’s products and services is inelastic, it means that the company can sell the same volume regardless of the price it sets for its products and services.

A company can achieve market power through product differentiation and innovation.

If a company creates a new and innovative product, it can temporarily be a monopoly in the market until other companies catch up.

It’s possible for a company to exercise dominance in a market as it has access to information that other market players do not have.

As such, it can make better strategic decisions allowing it to further consolidate its market power.

In addition, market power can be achieved by preventing other competitors from entering the market.

The harder it is for new players to win over customers or gain access to the marketplace, the more the current players can exercise dominance. 

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How To Measure Market Power

Although the concept of market power is simple to grasp, it is however quite challenging to actually measure a company’s market power.

There are many ways that a company’s market power can be measured.

One method is to look at the extent to which the price exceeds the company’s marginal costs or average variable costs.

Another method is to measure the price elasticity of demand and the company’s ability to raise prices.

Typically, governments will evaluate a company’s market power and dominance by assessing if the company’s dominance hinders competition or can reduce it.

In essence, market power is assessed based on the company’s impact on the market, ability to increase prices and maintain them, the company’s behavior in the market, and the substantial lessening of competition.

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Market Power FAQ

What are the different types of market power?

There are essentially four types of market power, monopoly, monopolistic competition, oligopoly, and perfect competition.

Monopoly is when one company exclusively serves a market and sets prices.

Monopolistic competition is when a few firms dominate a market and can raise prices without losing their customer base.

Oligopoly is when a few firms dominate the market collectively without any individual company exercising substantial market power.

Perfect competition is when no single company has the ability to influence the market in any way.

What are the main factors influencing market power?

The main factors influencing market power are:

• The number of competitors competing in the space
• Demand elasticity 
• Product differentiation 
• Pricing power
• Barriers to entry 
• Government policies and regulations 
• Brand loyalty 
• High startup costs 

How do you measure a company’s market power?

There are different ways that a company’s market power can be measured.

Typically, you can look at a company’s market power by analyzing the difference between its price and marginal cost.

You can also use other techniques such as the Lerner Index, Herfindahl-Hirschman Index, and Concentration Ratios.

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Takeaways 

So there you have it folks!

What does market power mean?

In a nutshell, market power is a measure of a company’s ability to set prices for its products and services in a particular market.

The more a company is able to influence prices without relinquishing market share, the more the company is said to have market power.

In the past decades, we have seen many companies exercise significant control and dominance in their industry such as Apple, Microsoft, Google, and others.

When a company’s power becomes detrimental to consumers and the overall economy, the government has the capacity to intervene and promote fair competition.

Now that you know what market power means and how it works, good luck with your research!

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