Market Power

In economics, market power is the ability of a firm to profitably raise the market price of a good or service over marginal cost. 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." Significant market power is when prices exceed marginal cost and long run average cost, so the firm makes economic profits.

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 behavior. 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 behavior can take place only through collusion, or the exercise of a group of participants' collective market power.

The Lerner index and Herfindahl index may be used to measure market power.