The Economics of Market Power

• Pages: 35-60

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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