Market Power - Source of Market Power

Source of Market Power

A monopoly can raise prices and retain customers because the monopoly has no competitors. If a customer has no other place to go to obtain the goods or services, they either pay the increased price or do without. Thus the key to market power is to preclude competition through high barriers of entry. Barriers to entry that are significant sources of market power are control of scarce resources, increasing returns to scale, technological superiority and government created barriers to entry. OPEC is an example of an organization that has market power due to control over scarce resources - oil. Increasing returns to scale are another important source of market power. Firms experiencing increasing returns to scale are also experiencing decreasing average total costs. Firms in such industries become more profitable with size. Therefore over time the industry is dominated by a few large firms. This dominance makes it difficult for start up firms to succeed. Firms like power companies, cable television companies and wireless communication companies with large start up costs fall within this category. A company wishing to enter such industries must have the financial ability to spend millions of dollars before starting operations and generating any revenue. Similarly established firms also have a competitive advantage over new firms. An established firm threatened by a new competitor can lower prices to drive out the competition. Microsoft is a firm that has substantial pricing or market power due to technological superiority in its design and production processes. Finally government created barriers to entry can be a source of market power. A prime example are patents granted to pharmaceutical companies. These patents give the drug companies a virtual monopoly in the protected product for the term of the patent.