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7.2: Market Power

  • Page ID
    210853
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    When new firms join or leave an industry, the industry’s market structure changes. This should make intuitive sense because, after all, market structure measures the level of competition. But market structure involves another dimension. The second part of market structure is market power. See figure 4.

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    Figure 4

    Figure 4 shows how the level of market power changes as the market structure changes. Notice how market power diminishes as the industry structure moves towards perfect competition and grows when the structure moves to monopoly.

    Remember, market power means a firm in an industry can change the market price of a good or service. In module 3 we learned that the only things that can alter equilibrium price are a shift in the market demand or supply curves. So, if a firm has market power, then this means it must be able to shift one of these curves. The question is: Which curve?

    An effective marketing campaign can shift a market demand curve. But marketing has only an indirect effect because the advertising firm does not force a customer to buy; it only persuades. Now, if a firm decides to produce more at all price levels, then it could directly cause a shift in the market supply curve. In this module, shifting supply will be the way a firm wields market power.

    Firms in a perfectly competitive industry are very small and represent only a small fraction of the market supply. If one firm decides to increase output this will have virtually no effect on the market supply. If there is no shift, then there is no change to the market price.

    Note

    People often think that the term monopoly implies "big business." Keep in mind that a monopoly only means having a single seller. There are plenty of small businesses that are monopolies. Our next example will prove this point.

    A good example of monopoly market power comes from the art industry. The art industry, broadly defined, is very competitive. There are millions of artists competing to sell their productions. But when you narrow the definition of the industry you can easily find artists who produce art using a unique style or medium. These one-of-a-kind artists are monopolists.

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    What if a successful artist wanted to make more money by selling more paintings through more art galleries?

    Increasing the number of galleries that sell this painter’s art is a good idea if the painter is careful how it is done. The key is to control the amount of art on the market, the number of galleries that sell it, and where those galleries are. If the painter saturates the market with art or gives too many galleries the right to sell it, the price will fall. See figure 5.

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    Figure 5

    Since the artist produced 100% of the market supply, the tripling of output (from two painting to six) shifted the market shifted the market supply curve to the right. This new market supply curve intersects the market demand curve in a new location (i.e., new equilibrium point). The increase in overall supply lowered the price for the paintings. Because the change in output caused a shift in the market supply, we can conclude that this artist has market power.


    This page titled 7.2: Market Power is shared under a not declared license and was authored, remixed, and/or curated by Martin Medeiros.

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