Market power

Market power typically reflects a situation in which firms have the capacity to set soaring prices without losing market concentration, i.e., without decreasing their market share. To better understand market power, it is important to understand a perfect competitive market. Markets in perfect competition are characterized by many sellers supplying goods that are perfect substitutes (consumers cannot differentiate the supplier by looking the good). Under this scenario, firms have no market power because any attempt to increase the price will lead to a situation in which any consumer will buy these goods (consumers may acquire the same goods at a lower price from another supplier). Therefore, suppliers may enjoy market power in the sense that small price changes do not lead to drastic changes in demand (Belleflamme & Peitz, 2015).   Studying this topic is relevant because firms that enjoy market power can set prices higher than their marginal cost without losing its clients leading to welfare losses for societies (Tirole, 1988). Note that firms that set a price equal to their marginal cost can operate without incurring losses. Therefore, goods traded at higher prices represent an extra burden for consumers.   Economists have identified different conditions that lead to market power. For instance, product differentiation raises market power. Firms may strategically choose their location in cities or offer better quality to differentiate themselves from the rest of suppliers. Another example resides in the information available for consumers. Firms might exert market power over imperfectly informed consumers who may incur costs to search prices from other alternatives (Belleflamme & Peitz, 2015).