Market Power

Updated on January 30, 2024
Article byHimani Bhatt
Reviewed byDheeraj Vaidya, CFA, FRM

Market Power Definition

Market power (MP) is the potential of a firm(s) to influence the market price of a good or service by controlling its demand and/or supply. It allows the firm to sets the price of its products as desired without the fear of losing sales. Selling at higher prices enables the firm with MP to rake in substantial profits.  

Market Power

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MP varies according to market structures. For example, monopoly best describes the concept of a sole enterprise holding substantial MP. On the contrary, firms operating in a perfectly competitive market have zero MP. Companies possessing MP are also referred to as price makersPrice MakersPrice maker (P-M) refers to a firm having enough market power to control the market prices of its products and services without losing its customers.read more or price setters as they can decide the market rate of an item.

Key Takeaways

  • Market Power is a firm’s ability to set the price of its product or service without losing market share.
  • It depends on the type of market structure, i.e., Perfect competition, Monopolistic competition, Monopoly, and Oligopoly.
  • Regulators utilize different analytical techniques like the Herfindahl-Hirschman Index and Concentration Ratios to measure market power.
  • There are three crucial sources of market power: Demand elasticity, high barriers to market entry or exit, and a number of market competitors.

Market Power Explained

MP is the ability of a company to fix the price of its product profitably above the prevailing rates in the market without losing its target clientele. A company with MP enjoys predominance as it can potentially impact the pricing of products or services in the marketplace.

An enterprise obtains considerable MP when its prices surpass marginal cost substantially. Note that it is immensely hard to measure MP. However, regulators employ diagnostic techniques like the Herfindahl-Hirschman IndexHerfindahl-Hirschman IndexHerfindahl-Hirschman Index or HHI score refers to a measure of market concentration and indicates the amount of competition in a particular industry. read more and Concentration Ratios to supervise market competitiveness.

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Types of Market Power

There are four key types of market systems: Perfect competitionPerfect CompetitionPerfect competition is a market in which there are a large number of buyers and sellers, all of whom initiate the buying and selling mechanism. Furthermore, no restrictions apply in such markets, and there is no direct competition. It is assumed that all of the sellers sell identical or homogenous products.read more, Monopolistic competitionMonopolistic CompetitionBeauty products are classic examples of monopolistic competition, with a large number of sellers and similar but not identical products sold by each company. Moreover, the entry and exit barriers to this business are relatively low.read more, Monopoly, and OligopolyOligopolyAn oligopoly in economics refers to a market structure comprising multiple big companies that dominate a particular sector through restrictive trade practices, such as collusion and market sharing. Oligopolists seek to maximize market profits while minimizing market competition through non-price competition and product differentiation. read more. Companies under each market system possess a varying degree of market power.  

Market Structure

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#1 – Perfect Competition

In this market structure, there are multiple sellers of a standardized product with no restrictions on market entry or exit. However, due to the homogeneity of their items, each seller faces unprecedented competition and enjoys only a small market shareMarket ShareThe share market is a public exchange where one can buy and sell company shares based on the demand and supply of shares. read more. Hence, no single firm has the power to fix a rate for the entire industry. 

Examples include Internet-related companies, agricultural markets, and foreign-exchange markets. 

#2 – Monopolistic Competition

A monopolistic competitive market comprises firms selling similar but diversified items within the same industry. These few firms have shared power and can raise the price tag without losing their customer base. Unlike a perfectly competitive market, they have barriers to market entry and exit. 

Examples include electronics, clothing, and consumer services like make-up, bars, spas, and hotels.  

#3 – Monopoly

A monopoly exists when there is only one seller of an exclusive product or service without close alternatives. Under monopoly, the seller enjoys significant market power and ensures massive net profit due to inelastic demand. However, this market structure comes with high restrictions for new entrants. 

Railways, Standard Oil, Facebook, Google, and AT&T are notable monopoly examplesMonopoly ExamplesMonopoly is the “one-&-only” seller of a good or service in the market & it faces no competition from any other entity. Generally, it is controlled or monitored by the Government to safeguard the customers’ interests. read more

#4 – Oligopoly

In this market structure, a few dominant firms have a major collective, but no individual power. An oligopolistic marketplace also has considerable barriers for new entrants. For instance, the airlines, cellular networks, and steel industry. 

Market Power Examples

Example #1

Say a company titled “Classic Health Diagnostics” (CHD) holds relevant MP in the healthcare industry. Thus, it can increase or decrease healthcare equipment or service rates by dominating the supply and/or demand level. 

It may directly increase the price of its product to earn more profits. Or, it can reduce the supply level to generate more demand and produce more revenueRevenueRevenue is the amount of money that a business can earn in its normal course of business by selling its goods and services. In the case of the federal government, it refers to the total amount of income generated from taxes, which remains unfiltered from any deductions.read more either way. So, while CHD is the “price maker,” the other healthcare firms with no MP are “price takers.” 

Example #2

Now, let’s take a real-life example. The well-established firm Facebook started off a decade back as a pioneering firm in the social media sector. However, over time it has come to dominate the social network by acquiring web-based texting company Whatsapp and photo-sharing platform Instagram.

A CNBC report rightly adjudges Facebook as a monopoly with unyielding MP. According to the article, Facebook buys, clones, or destroys its competitors to retain its MP. Apart from that, its monopoly over user data has been a threat to people and government alike. 

As a result, it has lately drawn a lot of flak for its anti-competitive behavior and data breaches. Consequently, several legal cases were filed against it. However, with its MP and monopolistic tendencies, it is likely to continue to rule the roost in the social network industry.

Sources of Market Power

There are numerous sources of MP. Here lies the description for the top three sources. 

#1 – High Market Entry or Exit Barriers

An industry with extremely high barriers related to market exit or entry offers a sense of dominance to the current players. As they are secured, and the possibility of new entrants is almost negligible, the existing players enjoy considerable MP. 

#2 – Number of Market Competitors

MP is inversely proportional to the number of market competitors. Therefore, you may hold extensive MP only if you are among the limited product or service providers in the marketplace. Conversely, your MP will reduce in the case of multiple rivals. Therefore, the more the competitors, the less the MP!

#3 – Constant Product Demand

There must be a persistent product demand irrespective of the legal amendments, product pricing, and current scenario. It will guarantee your hold on the MP no matter what tomorrow brings. A firm can produce an inelastic product demand by introducing a unique item in the marketplace that may add value to the customer’s life. 

Frequently Ask Questions (FAQs)

Q#1 – How to measure market power (MP)?

A – It isn’t easy to measure MP. It is usually determined by measuring the difference between price and marginal cost. Besides, regulators also use different mathematical techniques like Learner Index, Herfindahl-Hirschman Index, and Concentration Ratios for calculating it.

Q#2 – What are the top five sources of market power?

A – The top five sources of MP are the number of market competitors, continual product demand, market entry or exit barriers, product differentiation, and governmental regulations.

Q#3 – Is market power a good or bad concept?

A – It depends upon how the firm utilizes its power. A few of them gain profits but do not let the marketplace tumble. However, some firms only focus on their monetary gains and let society suffer. Consequently, people end up paying more than required for the products or services, and the nation experiences poverty.

Q#4 – Under which market structure does a company enjoy the most market power?

A – The Monopoly market structure gives the most market power to a company. It refers to a system where a single supplier has complete dominance across the marketplace. It is the only provider of a unique product or service with no available substitutes.

This has been a guide to What is Market Power and its Definition. Here we explain types of market power, its sources, along with examples. You may learn more about financing from the following articles –

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