Module 10 – Market Power

Perfect competition is rare

most firms have at least some market power

Market power

allows a firm to charge prices above marginal cost, reducing total surplus but increasing producer surplus

Firms in imperfectly competitive markets

face downward-sloping demand curves, unlike the horizontal demand in perfect competition

Types of market structures

• Perfect competition

• Monopolistic competition

• Oligopoly

• Monopoly

Perfect Competition

Many firms, identical products, no barriers to entry 

Monopolistic competition

Many firms, differentiated products, low barriers to entry

Oligopoly

Few firms, same or differentiated product, some barriers to entry

Monopoly

One firm, unique product, high barriers to entry

Market power can come from

Barriers to entry & product differentiation

Barriers to entry

patents, government regulation, control of key resources

Product differentiation

branding, advertising, quality

Imperfect Competition Result

Firms can set price above marginal cost → deadweight loss occurs due to underproduction

Imperfect Competition Key Idea

More competition = less market power = greater efficiency

A monopoly exists when

a single firm is the sole producer of a product with no close substitutes

Sources of monopoly power

• Control of key resources

• Government regulation

• Network effects

• Natural monopoly

Government regulation

patents, licenses

Network effects

value increases with user base

Natural monopoly

when large fixed costs and low marginal costs make one firm most efficient (e.g., utilities)

A monopolist faces

a downward-sloping demand curve

Monopoly price and output decision

To sell more, it must lower price → MR < Price

Profit-maximizing rule

produce where MR = MC, then set price from the demand curve

Monopoly Example

• Demand: P=10−Q100; MR: 10−Q50​; MC = 3.

• Monopoly price = $6, Q = 400; Competitive price = $3, Q = 700.

• The difference in lost transactions = deadweight loss

Consumer surplus shrinks

producer surplus rises; total surplus falls

Monopolists restrict

output below the efficient level

Competitiveness of an industry depends on five main forces

• Existing competitors

• Potential competitors

• Substitute goods

• Bargaining power of buyers

• Bargaining power of suppliers

Existing competitors

How similar are the goods? Can firms differentiate?

Potential competitors

New entrants threaten market power. Example: If Uber tripled prices, new ride-sharing firms would emerge

Substitute goods

Firms also compete across industries (e.g., Amazon vs. Walmart; new vs. used cars)

Bargaining power of buyers

Large buyers can demand lower prices (e.g., McDonald’s vs. small diner buying potatoes)

Bargaining power of suppliers

Suppliers with market power or high switching costs (like specialized software) can raise costs

Switching costs

increase supplier power — it’s expensive or difficult to change providers

Firms in competitive markets must innovate constantly to earn profits

lowering costs, improving efficiency, and creating value for consumers

Pro-market

supports competition, increases efficiency

Pro-business

protects existing firms, reduces efficiency

Why is a burger more expensive at the only diner on a highway?

less competition = more market power

Why do successful firms lose their edge?

entry erodes profits

Price Discrimination

Selling the same good at different prices to different buyers

Price discrimination in not about prejudice

it’s about charging based on willingness to pay

Perfect price discrimination

Each buyer pays their reservation price (maximum willingness to pay).

Perfect price discrimination eliminates

consumer surplus → all surplus goes to producer

Perfect price discrimination makes deadweight loss

disappears, total surplus is maximized (though unevenly distributed).

Perfect price discrimination example

• Market power allows price = $6, Q = 400; perfect discrimination increases Q to 700 (competitive quantity).

• Every buyer pays their own willingness to pay, so no discount effect.

Three conditions for price discrimination

• Market power

• No resale

• Ability to segment market

No resale

buyers can’t resell to others

Ability to segment market

firm can identify and charge groups differently

Price discrimination common examples

• Discounts for students, seniors, or “new customers.”

• Personalized pricing (e.g., airline tickets, financial aid, dynamic pricing).

• “Cheap movie tickets but expensive popcorn.”

Price discrimination key takeaway

Price discrimination redistributes surplus from consumers to producers but can increase total efficiency by expanding quantity sold

How do firms segment markets?

• Group pricing

• Hurdle method

• Tying and bundling

Group pricing

• Different groups, different prices (e.g., students, seniors, locals).

• Must rely on verifiable and difficult-to-change characteristics (e.g., .edu email, ID).

• Example: Apple sells laptops for $1000 to students and $1200 to non-students.

Hurdle method

• Buyers “self-sort” based on willingness to pay.

• Example: airline tickets—business travelers pay more (last-minute, refundable tickets) vs. leisure travelers (advance, nonrefundable).

Time/hassle hurdles

coupons, rebates—only low-WTP consumers bother

Quantity discounts

buying in bulk reveals lower WTP for extra units

Tying

A product is only usable with another product from the same firm (e.g., printers and ink cartridges)

Tying: Printer = low price, ink = high price

firm shifts markup to inelastic product

Bundling Example: Burger = $7 WTP, fries + drink = $2

• You = $9 total; another person values differently ($4 + $4).

• Bundle at $7.50 → both buy → revenue increases from $9 → $15.

Price discrimination is an application of marginal analysis

firms adjust prices to capture more consumer surplus

Price discrimination rely on

differences in willingness to pay, opportunity cost, and marginal benefit