What is Market Power?
Market power refers to a company's relative ability to manipulate the price of an item in the marketplace by manipulating the level of supply, demand or both.
A company with substantial market power has the ability to manipulate market price and thereby control its profit margin, and possibly the ability to increase obstacles to potential new entrants into the market. Firms that have market power are often described as "price makers" because they can establish or adjust the marketplace price of an item without relinquishing market share.
Market power is also known as 'pricing power'.
[Important: In a market where many producers exist that compete with each other to sell a similar product, such as wheat or oil, producers have very limited market power.]
Understanding Market Power
Market power can be understood as the level of influence that a company has on determining market price, either for a specific product or generally within its industry. An example of market power is Apple Inc. in the smartphone market. Although Apple cannot completely control the market, its iPhone product has a substantial amount of market share and customer loyalty, so it has the ability to affect overall pricing in the smartphone market.
The ideal marketplace condition is what is referred to as a state of perfect competition, in which there are numerous companies producing competing products, and no company has any significant level of market power. In markets with perfect or near-perfect competition, producers have little pricing power and so must be price-takers.
Of course, that is merely a theoretical ideal that rarely exists in actual practice. Many countries have antitrust laws or similar legislation designed to limit the market power of any one company. Market power is often a consideration in government approval of mergers. A merger is unlikely to be approved if it is believed that the resulting company would constitute a monopoly or would become a company with inordinate market power.
The scarcity of a resource or raw material can play a significant role in pricing power, even more so than the presence of rival providers of a product. For example, various threats, such as disasters that put the oil supply at risk, lead to higher prices from petroleum companies, despite the fact that rival providers exist and compete in the market. The narrow availability of oil, combined with the widespread reliance on the resource across multiple industries means that oil companies retain significant pricing power over this commodity.
- Market power refers to a company's relative ability to manipulate the price of an item in the marketplace by manipulating the level of supply, demand or both.
- In markets with perfect or near-perfect competition, producers have little pricing power and so must be price-takers.
- In monopolistic or oligopolistic markets, producers have far more market power.
Example of Market Power
For example, when the iPhone was initially introduced by Apple, the company had substantial market power as it essentially defined the smartphone and app market with the launch of the product - it was for a short period of time the monopoly.
At the time, the cost to procure an iPhone was high and could remain so because of a lack of rival devices. iPhone prices were thus set initially by Apple and not by the marketplace. Even as the first competitor smartphones emerged, the iPhone continued to represent the high end of the market in terms of pricing and expected quality. As the rest of the industry began to catch up in service, quality, and availability of apps, Apple’s market power diminished. The iPhone did not vanish from the market as more entrants arrived. Apple began to offer new models of iPhones in multiple variations, including less-expensive models targeted at more budget-minded consumers.
Power Structures of Markets
There are three basic marketplace conditions that exist in terms of market power, as applied to either an overall economy or a marketplace for a specific item.
The first is the previously noted ideal condition of perfect competition. With perfect competition, in addition to a number of companies producing the same or a similar product, there are also minimal or no barriers to new companies entering the marketplace. Agricultural markets are often pointed to as examples of relatively perfect competition markets since it is nearly impossible for any one producer of an agricultural commodity to gain a substantial amount of market power.
The opposite of perfect competition conditions is a monopoly in which one company completely controls the market for a product or service, or at least a portion of the total market, and is able to adjust pricing at will. Limited monopolies are often allowed for utility companies, but their ability to raise prices is usually limited by government authority.
An oligopoly refers to a marketplace dominated by a small number of companies, and in which there are substantial barriers to new entrants in the market. The companies in an oligopoly generally have combined, but not an individual, market power. An example of oligopoly is the market for cellphone service, controlled by a relatively small number of firms, in which large barriers to new entrants exist.
[Fast Fact: Monopsonies are markets where only one buyer exists among several producers. For instance the government as a purchaser of military planes. Producers will have little market power in such a case but the buyer will.]