Market power: definition and measurement

Oligopoly

Price and mark up,

price stickiness.

Market power

• Definition: Degree of control over the price and the quantity produced in a sector (by one or a few firms)

• Measurement through an index of concentration of production by larger companies (the first 4 or 8)

• The concentration is high in oligopolistic markets

• prices are sticky

The concentration ratio is a measure of the total output produced in an industry by a given number of firms in the

industry. It measures the degree of control exercised by a few firms in an industry

Concentration measured by the value of dispatch in manifacturing industries, United States4 major firms subsequent 4 major firms

Tobacco

Household refrigerators

Bulbs

Vehicles

Greeting cards

Blast furnaces

Screws

Metal tools

Percentage of total dispatches

Oligopoly• Market with few producers

• Awareness that the actions of each participant (eg, choice of price, advertising, changes in production quality etc.) affect all the others.

• Direct comparison between companies

• An oligopoly can be characterized by collusion or by a competition between companies

Collusion and cartels

• COLLUSION

• -Implicit or explicit agreement between firms to avoid or limit competition

• CARTEL– Formal agreement between companies aimed

to prevent or restrict competition• E.g.: OPEC

Collusion is prohibited (antitrust law), however it is more difficult when:

• There are many companies in the sector

• The product is not homogeneous

• The demand and cost conditions change rapidly

• There are not barriers to entry

• companies have excess of production capacity

Management difficulties of a cartel: the case of OPEC

• Many producing countries

• Agreements based on the quantity

• Producers do not respect the quotas

• Volatility of demand

• Prices vary considerably and cause disputes between producers

Non-collusive oligopoly

• For every action the single firm have to anticipate the reaction of competitors

• Risk of a price war

• Great caution in changes

• Prices tend to be "sticky“

• Price are modified only in the face of major and permanent changes in costs

Strategic barriers to entry

• Some barriers to entry are created by existing firms strategically: – Predatory pricing– Excess capacity– Advertising and R&D– Product proliferation

• Actions which oblige potential entrants to incur in sunk costs

Comparison with perfect competition

• Perfect competition is the most favourable market for consumers

• In oligopoly prices tend to be higher than the minimum average total cost

• Should we take action to eliminate any oligopoly?

• It would not be technically possible and even advantageous in a long term perspective

Is it desirable to eliminate market imperfections and oligopoly?

•Large companies are those that invest more in R & D (Schumpeter’s hypothesis: large firms have helped to raise the standard of living rather than hold it down)

•The fragmentation of the industry slow down technological progress

•Large firms are also a professional "school“, they foster the formation of human capital, necessary for development

•It should rather control the action of those who operate in oligopolistic markets and prevent the abuse of dominant position (antitrust law)

Role of small and medium-sized firms

• The lack of economies of scale is often compensated by the higher flexibility

• Despite the lack of (or the low) investment in R&D, several successful cases of innovation by small firms

• CONCLUSION: To obtain innovation and progress in the economic system there must be a variety of situations and methods, combined with the best guarantees for everyone to express free initiatives