Chapter_4_modified_2[1].pptx for economics

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1. CHAPTER FOUR DEFINITION, MEASUREMENT , DETERMINANT, PRONE AND CONS OF MARKET POWER

2. Objectives of the study After completing this chapter, student should able: To define market power To explain Determinants of market power To describe measurement of market power and To list advantages and disadvantages of market power

3. 4.1. Measurement of Market power 4.1.1.Definition of market power In  Economics   market power  refers to the ability of a  firm  to influence the price at which it sells a product or service to increase economic profit. In other words, market power occurs if a firm does not face a perfectly elastic demand curve and can set its price (P) above marginal cost (MC) without losing sales. This indicates that the magnitude of market power is associated with the gap between Price(P) and marginal cost (MC) at a firm's profit maximizing level of output.

4. A company with substantial market power has the ability to manipulate the market price and there by 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 market price of an item without relinquishing market share.

5. An example of market power is  Apple Inc.   in the smartphone market . Although Apple cannot completely control the market, its i-Phone product has a substantial amount of market share and customer loyalty, so it has the ability to affect overall pricing in the smartphone market.

6. Measurement of Market Power Market power can be measured using various indicators, including: 1. Market share : The percentage of total sales or production in a market that is captured by a single firm or a group of firms. 2 . Concentration ratios : These ratios measure the combined market share of the largest firms in an industry. Common concentration ratios include the 4-firm concentration ratio and the Herfindahl -Hirschman Index (HHI). 3. Price-cost margins : The difference between the price of a product and the cost of producing it. A higher price-cost margin indicates greater market power. 4. Profit margins : The percentage of revenue that remains as profit after all expenses have been deducted. Higher profit margins can indicate greater market power. 5. Price elasticity of demand : Measures the responsiveness of quantity demanded to changes in price. Firms with greater market power are able to raise prices without experiencing a significant decrease in demand . 6. The Lerner Index (LI) : is the best known measure of monopoly power. It is expressed as: LI= p-mc/p

7. 4.1.2.Market Power in Different Market Concentrations There is no market power in PCM at all while there is some market power since firm is price maker in the monopolistic competition. However, Monopolist have very high or absolute market power since firm is price maker, no competition and can be able to charge different prices.

8. 4.1.3.Determinants of Market Power The market power of organizations is threatened, when there is a new entrant in the market. Thus, as long as there are barriers to entry, the market power of the existing organizations remains strong. These barriers often act as the determinants of market power of organizations. For example , retail stores have generally very low market power as it is easy for a new participant to enter the market.

9. There are various determinants of market power that explain the existence of organizations' control in the market. There are 4 major  determinants of market power : Economies of scale Governmental regulations Control of raw materials Customer loyalty

10. 1. Economies of scale It often occurs that the organization that has a fair amount of the share in the market produces large quantities to maximize its profit. Thus , when a new organization decides to enter the market, it has to produce in large quantities to keep its cost low in comparison to the other market rulers/participants. Thus , Economies of scale actually indicate the market power of an organization in the market.

11. 2. Governmental regulations Governmental regulations also act as a major determinant of market power. In the market, where these regulations are strict and numerous, there is a strong control of the existing organizations. For instance , by licensing and franchising monopolies are created along with government decree. In such a scenario, starting up a new venture becomes difficult due to the high market power of the leaders.

12. 3. Control of raw materials An important determinant of market power is the control of raw material supplies in the market. For instance , an organization that controls the supply of all the raw materials required for a product in the market may refuse to sell the raw materials at low prices to make the manufacturing organizations compete.

13. 4. Customer loyalty With time, an organization builds its reputation in the market. In the eyes of customers too, these organizations hold a great image. Thus, customers find it difficult to switch to other products, even at a high price. Due to brand establishment in the market, the market power of the organization remains high making and it would be difficult for new entrants to gain share in the market.

14. Overall, market power affected by: Number of competitors in a market Elasticity of demand Product differentiation Ability of companies to make above “normal profit” Pricing power Perfect information Barriers to entry or exit Factor mobility

15. 4.1.4.Sources of market power There are several sources of market power including : High barriers to entry. Increasing returns to scale. High start-up costs. Brand loyalty of consumers and value placed by consumers on reputation. Government policies/regulations.

16.   4.1.5.Prone and Cons of Market power i. Pros: Advantage of Market power A. The employees working in the company that have market power might feel relief with a sense of thought that these companies have the least chances of getting collapsed and so their jobs will not get lost The respective nations tend to rely upon these companies because of their ability to increase investment opportunities and to come up with new ideas in diverse fields. B. By selling unique products, they contribute a lot to the respective nation's growth, which even increases during festive seasons.

17. C. The advantage of being large Economies of scope and economies of scale are two concepts that explain why costs are often lower for larger companies. Economies of scope focus on the average total cost of production of a variety of goods. In contrast, economies of scale focus on the cost advantage that arises when there is a higher level of production for one good.

18. ii. Cons : Disadvantage of having market power A. The new startups fail to prosper because of several restrictions which are often created by companies which have market power and dominant for which they fail to come up with substitutes . B . The consumers are often charged high prices for which the poor people fail to purchase during emergency times, and other this price discrimination and dumping often takes place to exploit consumers . Thus it brings Reducing consumer surplus and economic welfare.

19. C. X-inefficiency X-inefficiency happens  when a lack of effective / real competition in a market or industry means that average costs are higher than they would be with competition. D. Rent-seeking It is   a concept in economics that states that an individual or an entity seeks to increase their own wealth without creating any benefits or wealth to the society . Rent-seeking activities aim to obtain financial gains and benefits through the manipulation of the distribution of economic resources.

20. E. Dead weight loss Firms which have market power causes social welfare loss and distortions in resource allocation. When firms having market power exist supply and demand are out of equilibrium, creating a market inefficiency, a deadweight loss is created.  Dead weight loss benefit neither consumers nor firms.

21. 4.2.Entry deterrence I n the theories of competition in economics,  strategic entry deterrence  is when an existing firm within a market acts in a manner to discourage the entry of new potential firms to the market. These actions create greater  barriers to entry  for firms seeking entrance to the market and ensure that incumbent firms retain a large portion of  share. Deterring strategies, might include an  Excess Capacity,   Limit Pricing,   Predatory Pricing, predatory acquisition (Hostile takeover) and  Switching costs.

22. 1. Excess capacity Strategic excess capacity may be established to either reduce the viability of entry for potential firms.  Excess capacity take place when an incumbent firm threatens the new entrants possibility to increase their production output and establish an excess of supply, and then reduce the price to a level where the competing cannot contend.

23. Excess capacity typically occurs in markets with firms that have a  natural monopoly. Economist Dr. William W. Sharkey established five key aspects that lead to an monopolized industry The product or service is essential; The location for production supersedes alternatives; The outputs are not storable; The product is produced at an economies of scale; and The product is can only be produced by a single supplier.

24. 2.Limit pricing In a particular market an existing firm may be producing a  monopoly  level of output, and thereby making  supernormal profits. This creates an incentive for new firms to enter the market and attempt to capture some of these  profits. One way the incumbent can deter entry is to produce a higher quantity at a lower price than the  monopoly  level, a strategy known as  Limit pricing.

25. 3. Predatory pricing In a legal sense, a firm is often defined as engaging in  Predatory pricing  if its price is below its short-run  marginal cost . The rationale for this action is to drive the rival out of the market, and then raise prices once  monopoly  position is reclaimed.

26. 4. Predatory acquisition Predatory acquisitions occur when one firm seeks to purchase a share of a smaller target firm anonymous to the  management   of the target firm. Incumbent firms can eliminate the possibility of competition from entering firms by acquiring enough shares from the target firm in order to gain a desired level of control

27. 5.Switching costs A  Switching costs represents the expense a consumer faces in the light of changing to the product or service to a competing firms . Switching costs are not strictly monetary. The costs associated with switching commonly fall under three categories; procedural, financial, and relational . Procedural switching costs credited to the time and effort spent in completing the change. A firm might financially deter their customers from leaving by enforcing an  exit fee . Relational switching costs refer to the inconveniences that are evoked in learning to use the new product or service.