Market power


Institution Definition

Strength of a firm on a particular market. In basic economic terms, market power is the ability of firms to price above marginal cost and for this to be profitable. In competition analysis, market power is determined with the help of a structural analysis of the market, notably the calculation of market shares, which necessitates an examination of the availability of other producers of the same or of substitutable products (substitutability). An assessment of market power also needs to include an assessment of barriers to entry or growth (entry barriers) and of the rate of innovation. Furthermore, it may involve qualitative criteria, such as the financial resources, the vertical integration or the product range of the undertaking concerned. European Commission

The ability of a firm (or group of firms) to raise and maintain price above the level that would prevail under competition is referred to as market or monopoly power. The exercise of market power leads to reduced output and loss of economic welfare. Although a precise economic definition of market power can be put forward, the actual measurement of market power is not straightforward. One approach that has been suggested is the Lerner Index, i.e., the extent to which price exceeds marginal cost. However, since marginal cost is not easy to measure empirically, an alternative is to substitute average variable cost. Another approach is to measure the price elasticity of demand facing an individual firm since it is related to the firm’s price-cost (profit) margin and its ability to increase price. However, this measure is also difficult to compute. The actual or potential exercise of market power is used to determine whether or not substantial lessening of competition exists or is likely to occur. An approach adopted in the administration of merger policy in the United States and Canada seeks to predict whether, post-merger, the parties can institute a non- transitory price increase above a certain threshold level (say 5 or 10 per cent) which will vary depending on the case without attracting entry of new firms or production of substitute products. Their ability to maintain or exceed this price threshold is assessed by detailed examination of quantitative and qualitative market structure and firm behaviour factors. © OECD

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