The Economics of Market Power
Pages | 35-60 |
35
CHAPTER III
THE ECONOMICS OF MARKET POWER
In antitrust litigation and merger review, the concept of market
power is often in dispute. In economic theory, however, the subject is
largely well-settled and uncontroversial. Market power disputes in
antitrust litigation and merger review generally arise over differences in
factual assumptions or over the multiple meanings of the phrase “market
power.” Thus, understanding both the underlying theory and the variety
of commercial settings in which market power is analyzed has value.
This Chapter introduces the core economic concepts relating to market
power and discusses market power in both familiar and exceptional
settings.
A. Core Concepts: Supply, Demand, Marginal Cost, and Price
Elasticity
A prerequisite for intelligent reasoning about market power is an
understanding of four core concepts of microeconomics: supply, demand,
marginal cost, and price elasticity.
In economics, the term “supply” refers to a schedule that depicts the
amounts a supplier will offer at various prices: “How much will you
supply if the price is $1.50?”; “How much will you supply if the price is
$1.75?”; and so forth. Market supply at a given price is the sum across all
sellers of the amounts that they would be willing to supply at that price.1
1. See DENNIS W. CARLTON & JEFFREY M. PERLOFF, MODERN INDUSTRIAL
ORGANIZATION 61 (4th ed. 2005).
36 Market Power Handbook
A supply curve generally slopes upward from left to right (although
in principle it can be flat), as shown with curve S in Figure 1(a). Higher
quantities are supplied at higher prices. The higher the price an
individual supplier can obtain, the more it will supply because it can
recover the extra cost of supplying the increased volume.
The term “demand” refers to a schedule that depicts the amounts a
consumer would be willing to purchase at various prices. Market demand
at a given price is the sum across all consumers of the amounts that they
would be willing to purchase at that price. 2 One central idea in
economics is the law of demand—the empirical fact that demand
generally falls as price rises. 3 For consumer products, diminishing
marginal utility can give rise to the law of demand. Viewed from the
standpoint of consumers, we expect that as consumers purchase and
consume more units of a product, the incremental value of additional
consumption of the product diminishes. As this incremental value
diminishes, so does willingness to pay.4 Incorporating these demand
conditions into a typical market demand schedule, we associate lower
prices with larger quantities demanded. Demand curves therefore slope
downwards, as shown with curve D in Figure 1(a).
The equilibrium price in a competitive market is determined by the
intersection of the market’s demand and supply curves. In Figure 1(a),
2. See GEORGE J. STIGLER, THE THEORY OF PRICE 33-4 (4th ed. 1987).
3. See id. at 19-25.
4. See id. at 42-52.
Figure 1 A Perfectly-competitive Market
Price Price
S
D
MCf
Qf
Qc
PcPc
Quantity Quantity
Figure 1(a)
Market Supply and Demand
Figure 1(b)
A Competitive Firm’s
Supply and Demand
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