In the field of economics, market power is an ability of a firm to adjust or control the market price or volume of production of a product/s in the market. A firm with a market power absolutely raises its price without losing all customers to challengers. In the aggressive markets, there is no market power for market participants. A firm which has a market power has a capability to affect either the total quantity or current price in the market independently. If the increase in the prices of the commodity leads to a fall in demand, then the fall in supply of the market power creates an economic loss in comparison with circumstances of perfect competition. Generally, in operational terms, market power is involved in a firm’s monopoly or oligopoly which is also referred as competitive power. Usually, the market power can be measured by Tobin’s Q or simply Q ratio (wikepedia 2007[online]).
When the whole market structure of several firms controls the major share of market sales, then the resulting structure is referred as Oligopoly. The Oligopoly is also called as oligopsony. The main function of oligopoly is to engage in collusion, either by tacit or overt, and also thereby work out market power. An open agreement belonging to oligopoly is called as cartel which takes care of the market price or its resolution. Here, Oligopoly is a market conquered by some large dealers. The amount of market concentration is very high and leading firms will take a large percentage. Firms which are within an oligopoly produce more identified products. In that case, advertising and marketing is the major feature of competition in case of such markets and so, there is also no obstruction to other entries (Case Fair 2006).
Another important feature of an oligopoly is the dependence between two firms. This is nothing but, that each firm should always take into account the possible reactions of other firms in the market when they are making pricing and investment decisions. This may generate improbability in such markets. The behavior of firms in perfect case, in monopoly concept can be treated as a simple optimization (Tutor2u2007 [online]).
THE MAIN FEATURES OF OLIGOPOLY:
• Some of the firms are selling product with similarity.
• The production of each firms branded products.
• To make the barriers to enter into the market in the long run that allows firms to make supernormal profits.
• Inter-dependence between competing firms.
FEATURES OF MONOPOLY:
If a particular firm has one fourth of the market percentage, monopoly occurs. Monopoly is a state in which the market is dominated by any one of the seller or manufacturer. Monopoly power is an example of market breakdown that occurs when the member has the ability to control the price or other outcomes in a particular market.
MONOPOLYAND ITS BENEFITS:
• The firm makes top profits
• The firm usually invests its profits on new products or improves the existing products
DEMERITS OF MONOPOLY:
- The firm can hike the prices of the commodity according to its will
- Since the competition is eliminated, the consumer services are hampered
Capital Structure and Market Place. Volume 36, 2004
Principles of Microeconomics by Karl E. Case, Ray C. Fair
Wikipedia (2007). Market Power. Available: http://en.wikipedia.org/wiki/Market_power. Last accessed 26 October 2007.
Tutor2u.net. The Pricing Power of Businesses. Available: http://www.tutor2u.net/economics/
content/essentials/pricing_power.htm. Last accessed 25 October 2007.
Oligopoly is a market structure in which a few firm dominate the industry, it is an industry with a 5 firm concentration ratio of greater than 50%.
In Oligopoly, firms are interdependent; this means their decisions (price and output) depend upon how the other firms behave:
- Barriers to entry are likely to be a feature of Oligopoly
- There are different models to explain how firms may behave
The kinked demand curve model suggests firms will be profit maximisers.
Kinked Demand Curve Diagram
At p1 if firms increased their price, consumers would buy from the other firms, therefore, they would lose a large share of the market and demand will be elastic. Therefore, firms will lose revenue by increasing price
If firms cut price then they would gain a big increase in market share, however, it is unlikely that firms will allow this. Therefore, other firms follow suit and cut price as well. Therefore demand will only increase by a small amount: Demand is inelastic for a price cut and revenue would fall.
This model suggests price will be rigid because there is no incentive for firms to change the price
If prices are rigid and firms have little incentive to change prices they will concentrate on non-price competition. This occurs when firms seek to increase revenue and sales by various methods other than price.
For example, a firm could spend money on advertising to raise the profile of their product and try and increase brand loyalty, if successful this will increase market sales. Advertising is a big feature of many oligopolies such as soft drinks and cars. Alternatively, they could introduce loyalty cards or improve the quality of their after sales service. When buying a plane ticket price is not the only factor consumers look at, they may prefer airlines with more leg room, air miles e.t.c.
Non-price competition depends upon the nature of the product. For example, advertising is very important for soft drinks but less important for petrol.
However, in reality, this model doesn’t always occur. Often the objectives of firms are not to maximise profit. For example, they may wish to increase the size of their firm and maximise sales. If this is the case, they may be willing to take part in a price war, even if this does lead to lower profits. Price wars involve firms selling goods at very low prices to try and gain market share. For example, newspapers such as the Times and the Sun have recently been sold very cheaply. Price wars are more likely if:
- 1. Large firms are able to cross subsidise one market from profits elsewhere
- 2. In a recession, markets are more competitive as firms seek to retain customers
However, price wars may only be short-term
A firm may engage in predatory pricing, this occurs when the incumbent firm seeks to force a new firm out of business by selling at a very low price so that it cannot remain profitable.
Using game theory
Game theory looks at different possible outcomes of oligopoly – depending on how firms react to different decisions.
If the firms in oligopoly seek to increase market share the most likely outcome is that they both set low prices and make a low profit (£3m each) However if the firms could come to some agreement either formal or tacit collusion – they could both agree to raise prices. This will require the firms to reduce output and stick to the more limited supply. If they set high prices, then they will both be able to make monopoly profits (£8m each)
However, when prices are high, there is a temptation to undercut your rival and benefit from both high market prices and high output. This enables higher profit – £10m, but if firms start to cheat – then rivals are likely to retaliate by cutting prices too.
Collusion is possible in oligopoly, but it depends on several factors. Collusion is more likely if
1. There are a small number of firms, who are well known to each other – this makes it easier to stick to output quotas
2. A dominant firm, who is able to have a lot of influence in setting the price.
3. Barriers to entry, this is important to stop other firms entering to take advantage of the high profits
4. Effective communication and monitoring of output and costs
5. Similar production costs and therefore will want to raise prices at the same rate
6. Effective punishment strategies for firms who cheat
7. No effective government legislation, e.g. collusion is illegal in the UK.
There is no certainty in how firms will compete in Oligopoly; it depends upon the objectives of the firms, the contestability of the market and the nature of the product. Some oligopolies compete on price, other compete on the quality of the product.
Examples of Competition in oligopoly
Petrol is a homogenous product and so is likely to be quite stable in prices. Firms often move petrol prices in response to changes in the oil price. However, the introduction of supermarket own brand petrol has changed the market. Tesco and Sainsbury’s are more willing to sell cheaper petrol to attract customers to shop at their supermarket.
This takeaway coffee at 99p is quite cheap – suggesting a competitive oligopoly. However, for many customers, the price of coffee is secondary to the quality and environment of the coffee shop. Traditional coffee shops like Costa and Starbucks use more non-price competition to attract customers – as much as offering cheap prices.
In fact, there is a danger selling cheap coffee – may indicate to consumers lower quality