Question

Name two major consequences of market power.

Answer 1

Market power is the power of a firm to control price and supply of a product. The market power varies depending on the variation in imperfection of market. In a competitive market the market power is zero where the firms have no control over the price and output. Under oligopoly since the number of firms is few, the firms have control over the market and greater market share. In monopolistic competitive market since the number of firms is limited and products are something differentiated the firms have larger control over price and output. Lastly the monopoly is the extreme forms of imperfect competition and as a single seller controls the entire market, the monopolist can fix any price for the product by restricting output. The monopoly also practices price discrimination by taking the advantage of market share. Market power creates adverse consequences; some of them are listed below.

1. Inefficiency.

Market efficiency is maximum under perfect markets. For example the market of perfect competition ensures all types efficiencies like productive efficiency Allocative efficiency and dynamic efficiency. The productive efficiency is attained when the maximum output is obtained with minimum cost. But a monopoly having high market power operates below the maximum productive capacity in order to charge a high price from the consumers. Thus productive inefficiency is the adverse outcome of market power. The Allocative efficiency is also restricted under market power. The Allocative efficiency can be attained when the products are distributed at a point where marginal cost is equal to marginal benefit (MC=MB). But a firm having marker power charges a high price above the marginal cost. The firms having market power do not try to reduce cost through invention and innovations. Thus dynamic efficiency is also absent under the market power. In short all efficiencies are completely absent under a situation of market power.

2. Loss of economic welfare.

The firms having larger market share, exploit the consumers by charging a high price. The large part of consumer’s surplus is appropriated by the firm. This leads to the transfer of economic power in the hands of a few firms dominating the market. If we calculate the loss of satisfaction from the limited consumption and loss of production due to restrictive output policy, market power cause larger deadweight loss to the society.

In short the market power is abusive and it must be controlled by suitable legislation like antitrust laws and law of unfair trade practices.