Tip:
Highlight text to annotate it
X
The combination of these three factors gives rise to varying degrees
of market power. So, what does this mean? Well, it refers to the firm’s
degree of control over price. Is the firm a price taker or can it choose
its price and if so, how much would changing its price affect its profit?
Sounds counterintuitive to you; think of it this way. If you are in a
perfectly competitive market, you are just a small firm. You cannot set
your own price. If you set your own price above the market price, people
will just go to everyone else to buy their goods and since they sell
same goods, everyone else and there are so many of everyone else, you
won’t get anything; there are so many substitutes. So, you won’t want
to set your price the lower the market price either. Why would you want
to? You can earn it at the market price. But if you are a monopoly, you
get to set your own price unlike the perfectly competitive firm where
you take the market price because that isn’t the market dictating you.
So, market power refers to the amount of power you have over prices.
Market power occurs when there is less competition. So, perfectly
competitive firms have zero market power whereas monopolies have lots
of market power. A firm with high market power also has a very high price
inelastic demand curve. For example, in monopoly we have no choice but
to buy things that monopoly; there are no substitutes. Compare that to
a firm which is perfectly competitive; there are so many substitutes all
over the place. It’s demand curve is hence highly price elastic.