What Is Market Power?
Market power refers to a company's relative ability to manipulate the price of an item in the marketplace by manipulating the level of supply, demand, or both.
In doing so, such a company can thereby control its profit margin, and possibly the ability to increase obstacles to potential new entrants into the market. Firms that have market power are often described as "price makers" because they can establish or adjust the marketplace price of an item without relinquishing market share.
Market power is also known as pricing power.
In a market where many producers exist that compete with each other to sell a similar product, such as wheat or oil, producers have very limited market power.
Key Takeaways
- Market power refers to a company's relative ability to manipulate the price of an item in the marketplace by manipulating the level of supply, demand, or both.
- In markets with perfect or near-perfect competition, producers have little pricing power and must be price-takers.
- In monopolistic or oligopolistic markets, producers have far more market power and can be price makers.
Understanding Market Power
Market power can be understood as the level of influence that a company has on determining market price, either for a specific product or generally within its industry. Take, for instance, Apple Inc. in the smartphone market. Although Apple cannot completely control the market, its iPhone product has a substantial amount of market share and customer loyalty, so it has the ability to affect overall pricing.
The ideal marketplace condition is what is referred to as a state of perfect competition, in which there are numerous companies producing competing products, and no company has any significant level of market power. In markets with perfect or near-perfect competition, producers have little pricing power and so must be price-takers. Of course, that is merely a theoretical ideal that rarely exists in actual practice.
Many countries have antitrust laws or similar legislation designed to limit the market power of any one company. Market power is often a consideration in the government approval of mergers. A merger is unlikely to be approved if it is believed that the resulting company would constitute a monopoly or would become a company with inordinate market power.
The scarcity of a resource or raw material can play a significant role in pricing power, even more so than the presence of rival providers of a product. For example, various threats, such asdisasters that putthe oil supply at risk,lead to higher prices from petroleum companies, despite the fact that rival providers exist and compete in the market. The narrow availability of oil, combined with the widespread reliance on the resource across multiple industries means that oil companies retain significant pricing power over this commodity.
An Example of Market Power
When the iPhone was initially introduced by Apple, the company had substantial market power as it essentially defined the smartphone and app market with the launch of the product. For a short period of time, it had a monopoly.
At the time, the cost to procure an iPhone was high and could remain so because of a lack of rival devices. Thus, iPhone prices were set initially by Apple and not by the marketplace. Even as the first competitor smartphones emerged, the iPhone continued to represent the high end of the market in terms of pricing and expected quality. As the rest of the industry began to catch up in service, quality, and availability of apps, Apple’s market power diminished.
The iPhone did not vanish from the market as more entrants arrived. Apple began to offer new models of iPhones in multiple variations, including less-expensive models targeted at more budget-minded consumers.
Monopsonies are markets where one buyer has all the market power. This concept was developed by economist Joan Robinson in the 1933 book "The Economics of Imperfect Competition."
Power Structures of Markets
There are three basic marketplace conditions that exist in terms of market power, as applied to either an overall economy or a marketplace for a specific item.
The first is the previously noted ideal condition of perfect competition. With perfect competition, in addition to a number of companies producing the same or a similar product, there are also minimal or no barriers to new companies entering the marketplace. Agricultural markets are often pointed to as examples of relatively perfect competition markets since it is nearly impossible for anyone producer of an agricultural commodity to gain a substantial amount of market power.
The opposite of perfect competition conditions is a monopoly in which one company completely controls the market for a product or service, or at least a portion of the total market, and is able to adjust pricing at will. Limited monopolies are often allowed for utility companies, but their ability to raise prices is usually limited by government authority.
An oligopoly refers to a marketplace dominated by a small number of companies, and in which there are substantial barriers to new entrants in the market. The companies in an oligopoly generally have combined, but not an individual, market power. An example of oligopoly is the market for cellphone service, controlled by a relatively small number of firms, in which large barriers to new entrants exist.
What Is an Example of a Price Competition?
Consider the way that a consumer might shop for fruits and vegetables. They may browse produce sectinos at grocery stores, farmer's markets, superstores, and discount retailers across their city. Because there are many firms that sell produce, there will be some that set lower prices than others to entice shoppers. This is a form of price competition.
Who Has Market Power in a Competitive Market?
In a non-competitive market, such as in a monopoly, a single producer or multiple producers may hold disproportional power, allowing them to set prices as they wish. In a competitive market, the opposite is true: Buyers have power, and can respond to pricing changes by taking their business where they please.
Is Price-Fixing Legal?
Price-fixing refers to a practice in which multiple firm collaborate to set prices that would otherwise be determined by supply and demand within a competitive market. In general, it is illegal in the U.S. and suspected instances of price-fixing are subject to legal scrutiny and potential criminal prosecution.
The Bottom Line
Market power, also known as pricing power, refer to a company's relative ability to influence the price of products by manipulating supply, demand, or both. It enables companies to increase their profit margins and and impose barriers to entry for other firms. Many countries including the U.S. have antitrust laws that aim to limit the market power of any one firm.
