Market Power

Definition

Market power is the ability of a firm or group of firms to influence the price and output level of a product or service in the market. This concept is especially relevant in monopolistic competition, where firms sell similar but differentiated products, allowing them to have some control over their pricing. The degree of market power varies among firms, as it depends on factors such as brand loyalty, product differentiation, and the presence of close substitutes.

5 Must Know Facts For Your Next Test

1. In monopolistic competition, firms typically have some degree of market power due to product differentiation, which allows them to charge a higher price than the marginal cost.
2. The demand curve faced by a firm with market power is downward sloping, meaning that if the firm raises its price, it will lose some customers to competitors but can still retain others who prefer its unique product attributes.
3. Firms with market power can engage in non-price competition strategies, such as advertising and promotions, to strengthen their brand loyalty and further enhance their market position.
4. Market power is not absolute; it is influenced by factors like the availability of substitute products and the overall number of competitors in the market.
5. As firms enter the market and competition increases, individual firms' market power tends to decrease over time, leading to lower prices and increased consumer choice.

Review Questions

• How does product differentiation contribute to a firm's market power in monopolistic competition?
  • Product differentiation allows a firm to offer unique features or benefits that set its product apart from competitors. This uniqueness can create brand loyalty among consumers, giving the firm some control over pricing. In monopolistic competition, this means that even though there are many sellers, each firm can influence its own prices based on how much customers value its specific product attributes.
• Evaluate the impact of non-price competition on a firm's ability to maintain market power.
  • Non-price competition can significantly enhance a firm's market power by reinforcing brand loyalty and differentiating its products from those of competitors. Strategies such as advertising, enhanced customer service, and unique packaging create perceived value among consumers. When consumers are loyal to a brand due to these factors, they may be willing to pay higher prices, thus allowing the firm to maintain or even expand its market power despite competition.
• Analyze how an increase in the number of firms in a monopolistically competitive market affects existing firms' market power.
  • An increase in the number of firms within a monopolistically competitive market typically leads to greater competition and a dilution of existing firms' market power. As new entrants provide additional options for consumers, brand loyalty becomes more challenging to sustain. Consequently, existing firms may need to lower prices or enhance product features to retain customers. This shift not only reduces individual firms' pricing power but also encourages innovation and variety in products available to consumers.

Related terms

Price Maker: A firm that has the ability to set the price for its product rather than taking the market price as given.

Product Differentiation:

The process by which firms distinguish their products from those of competitors through variations in quality, features, or branding.

Monopolistic Competition:

A market structure characterized by many firms selling similar but not identical products, allowing for both competition and some degree of market power.