Unit 7 The firm and its customers

7.12 Influencing market power, and competition policy

Section 7.7 showed that when a firm charges a price above the marginal cost of production, the market outcome is not Pareto efficient and there is a deadweight loss. Market power may come from cost advantages or strategies to differentiate a product significantly from rival products. Research by economist Jan Eeckhout and his colleagues shows that there has been a steady increase in market power since the 1980s, with damaging effects on society. He argues that we urgently need to increase competition.

competition policy, antitrust policy

Government policies and laws to limit market power and prevent cartels, or to otherwise regulate the process of competition, are collectively known as competition policy or antiitrust policy.

Government policy to reduce market power and encourage competition is known as competition policy or antitrust policy. Competition authorities investigate cases where there is a concern that consumer and wider benefits from competition are lower than what is potentially feasible, because firms are limiting the scope for rivals in their market. This will normally arise in markets where one or a few dominant firms have high market share. But they only intervene if they conclude that firms have the ability and incentive to abuse their market power.

Firms may be able to influence both rivalry and elasticity of demand, limiting the extent of competition. A UK grocery market investigation in 2008 found that supermarkets had intentionally prevented other retailers from expanding or entering markets by buying up land and leaving it unused so that it was not available to others, and recommended that such behaviour should be prevented through changes to the planning laws.

Firms can exclude rivals by limiting their access to production inputs. In 2014, Ferrero, a market leader in chocolate confectionery, became the world’s largest producer of hazelnuts (a key ingredient of its product, Nutella) when it acquired one of its suppliers, Oltan. In this case, the European competition authorities approved the acquisition, arguing that there were enough other hazelnut suppliers to provide competition.

Patents and intellectual property rights also provide exclusive rights to an input to production—ideas. Patents incentivize R&D by providing temporary market power to a firm. Once they come to an end, we expect rival firms to enter the market. In the pharmaceuticals industry, generic drugs can be produced when patents have run out, leading to scope for competition after a period of time.

Limiting rival firms’ access to consumers is also exclusionary behaviour. Microsoft was investigated by US and EU antitrust authorities for preventing web browsers from being uploaded to their Windows operating system, so that rival software developers, such as Netscape, couldn’t reach a significant customer base.¹ After years of investigation, resulting in changes to Microsoft’s business model and millions of dollars in fines, a browser market developed. But Figure 7.27 shows that competition is dynamic: Google Chrome now has significant market power. Competition policy is often playing catch-up.

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https://www.core-econ.org/microeconomics/07-firm-and-customers-12-influencing-market-power.html#figure-7-27

Figure 7.27 Browser market share worldwide, 2009–2022.

Statcounter GlobalStats. Browser Market Share Worldwide, January 2009–August 2022.

Another way to reduce rivalry is by merging with other firms. Meta (Facebook) increased their market power across an ecosystem of products by buying other companies, including Instagram and WhatsApp. Competition authorities investigate potential harms from such mergers, but in some cases have found that the lower cost and consumer benefits from economies of scale, economies of scope, and network economies outweigh potential competition concerns. Economists argue that competition authorities need to consider wider economic effects from allowing such mergers.

Colluding with other firms by forming a cartel has a similar effect to a merger, with firms agreeing to behave like a monopoly. Cartels are illegal under most countries’ competition laws, but are difficult to prove. You can learn more about dynamics of oil prices, and the impact of OPEC, one of the most famous cartels, in Section 8.8.

A firm can also gain market power by making its customers less price-sensitive, for example, by using advertising to strengthen a brand, influencing product placement, or creating interconnected products.

Competition authorities need to assess all the potential harms and benefits of firms’ strategies on a case-by-case basis. In the case of natural monopolies, where there are cost advantages of very large scale, the appropriate policy response may be close regulation of prices or, in some cases, public ownership. Platform companies are proving a dilemma for policymakers, with natural monopoly-like characteristics due to scale and network effects, alongside competition with many advertisers and retailers using the platforms to reach customers. Debates continue about how they should be regulated.