Market power

In economics, market power is the ability of a firm to alter the market price of a good or
service. In perfectly competitive markets, market participants have no market power. A firm
with market power can raise prices without losing its customers to competitors. Market
participants that have market power are therefore sometimes referred to as "price makers,"
while those without are sometimes called "price takers."

A firm with market power has the ability to individually affect either the total quantity or the
prevailing price in the market. Price makers face a downward-sloping demand curve, such
that price increases lead to a lower quantity demanded. The decrease in supply as a result of
the exercise of market power creates an economic deadweight loss which is often viewed as
socially undesirable. As a result, many countries have anti-trust or other legislation intended
to limit the ability of firms to accrue market power. Such legislation often regulates mergers
and sometimes introduces a judicial power to compel divestiture.

A firm usually has market power by virtue of controlling a large portion of the market. In
extreme cases - monopoly and monopsony - the firm controls the entire market. However,
market size alone is not the only indicator of market power. Highly concentrated markets
may be contestable if there are no barriers to entry or exit, limiting the incumbent firm's
ability to raise its price above competitive levels.

Market power gives firms the ability to engage in unilateral anti-competitive behaviour.
Some of the behaviours that firms with market power are accused of engaging in include
predatory pricing, product tying, and creation of overcapacity or other barriers to entry. If no
individual participant in the market has significant market power, then anti-competitive
behaviour can take place only through collusion, or the exercise of a group of participants'
collective market power.

What Is Monopoly Power?

Monopoly firms set prices to maximize profits.
A monopoly is a market structure in which only one seller produces and sells a good or
service. Unlike firms in a competitive market, monopolies are able to determine their own
prices in order to maximize their profit. This price-making ability, unique to monopolies, is
known as monopoly power. Monopoly power arises due to barriers to entry--conditions that
make it difficult for other businesses to enter a market and compete with a monopoly firm.

Patents
Patents are a type of intellectual property law that provide a set of exclusive rights to an
inventor for a limited period in exchange for public disclosure of his invention. The
government gives the patent holder the right to exclude others from using his invention,
effectively creating a barrier to entry in the market. The patent, therefore, gives the holder a
monopoly on his creation for the duration of the patent, which is 17 years in the United
States.
Effects
Innovation creates profits with patent protection.
While the price-setting power that monopolies have can often create inefficiencies in a
market, in some cases government regulation will create monopolies because of other
positive effects monopolies may create. Governments permit creation of monopoly power
through patents because this tends to foster more innovation. Because research and
development is a costly process with no guarantee of success, firms will only innovate if their
new creations can provide enough profit to cover the cost of development. With patent
protection, firms have an incentive to innovate because they will be able to make profits on
any inventions they develop for the duration of the patent.

When Patents Expire

The monopoly power created by a patent is only temporary. When the patent expires, the
holder can no longer exclude other firms from producing or using her invention, and new
competitors will enter the market. This can be seen in the pharmaceuticals industry, where
cheaper, generic versions of brand-name drugs proliferate once the patent on the brand-name
drug expires.

Considerations
An interesting case of patent protection and monopoly power arises in the markets where
network effects are present. Network effects occur when a good increases in value as more
people use it. This is common in the software industry, where the software becomes more
useful as more users adopt it and can collaborate and share files and information with one
another. Monopoly power may extend beyond the patent's expiration if network effects are so
strong that competitors entering the market several years after the invention of the product
have difficulty attracting enough users to compete with the network effects associated with
the original, formerly patented product.

Sources of monopoly power

Monopolies derive their market power from barriers to entry - circumstances that prevent or
greatly impede a potential competitor's entry into the market or ability to compete in the
market. There are three major types of barriers to entry; economic, legal and deliberate.[6]

 Economic barriers: Economic barriers include economies of scale, capital

requirements, cost advantages and technological superiority. [7]

Economies of scale: Monopolies are characterised by declining costs over a relatively large
range of production.[8] Declining costs coupled with large start up costs give monopolies an
advantage over would be competitors. Monopolies are often in a position to cut prices
below a new entrant's operating costs and drive them out of the industry. [8] Further the size
of the industry relative to the minimum efficient scale may limit the number of firms that
 can effectively compete within the industry. If for example the industry is large enough to
support one firm of minimum efficient scale then other firms entering the industry will
operate at a size that is less than MES meaning that these firms cannot produce at an
average cost that is competitive with the dominant firm. Finally, if long run average cost is
constantly falling the least cost way to provide a good or service is through a single firm. [9]
Capital requirements: Production processes that require large investments of capital, or
large research and development costs or substantial sunk costs limit the number of firms in
an industry.[10] Large fixed costs also make it difficult for a small firm to enter an industry and
expand.[11]

Technological superiority: A monopoly may be better able to acquire, integrate and use the
best possible technology in producing its goods while entrants do not have the size or fiscal
muscle to use the best available technology. [8] In plain English one large firm can sometimes
produce goods cheaper than several small firms. [12]

No substitute goods: A monopoly sells a good for which there is no close substitutes. The
absence of substitutes makes the demand for the good relatively inelastic enabling
monopolies to extract positive profits.

Control of Natural Resources: A prime source of monopoly power is the control of resources
that are critical to the production of a final good.

Network Externalities: The use of a product by a person can affect the value of that product
to other people. This is the network effect. There is a direct relationship between the
proportion of people using a product and the demand for that product. In other words the
more people who are using a product the higher the probability of any individual starting to
use the product. This effect accounts for fads and fashion trends. [13] It also can play a crucial
role in the development or acquisition of market power. The most famous current example
is the market dominance of the Microsoft operating system in personal computers.

 Legal barriers: Legal rights can provide opportunity to monopolise the market in a
good. Intellectual property rights, including patents and copyrights, give a
monopolist exclusive control over the production and selling of certain goods.
Property rights may give a firm the exclusive control over the materials necessary to
produce a good.
 Deliberate Actions: A firm wanting to monopolise a market may engage in various
types of deliberate action to exclude competitors or eliminate competition. Such
actions include collusion, lobbying governmental authorities, and force.

In addition to barriers to entry and competition, barriers to exit may be a source of market
power. Barriers to exit are market conditions that make it difficult or expensive for a firm to
leave the market. High liquidation costs are a primary barrier to exit.[14] Market exit and
shutdown are separate events. The decision whether to shut down or operate is not affected
by exit barriers. A firm will shut down if price falls below minimum average variable costs.