Market power is the ability of a firm, or a group of firms acting together, to profitably maintain prices above the level that would prevail under effective competition. More broadly, it includes the ability to worsen quality, service, or other trading terms without being sufficiently constrained by rivals or customers switching elsewhere. In economics, the concept concerns the strength of competitive constraints, rather than simply a company’s size. It applies to sellers and, in an analogous form, to buyers. (justice.gov)
Economic foundations
Under the standard model of perfect competition, an individual firm takes the market price as given. A seller with market power instead faces demand that allows some discretion over price. Customers may still switch to substitute goods, but switching is insufficient to eliminate the firm’s ability to charge above marginal cost, the cost of producing an additional unit. Market power therefore does not imply unlimited pricing freedom: demand continues to constrain a profit-maximizing seller. (ocw.mit.edu)
A monopoly is the clearest structural example, but market power can also exist in oligopolies and monopolistic competition. Differentiated products may give individual sellers pricing discretion even when numerous competitors exist. Conversely, a large market share may provide little durable power if new suppliers can readily enter or existing rivals can expand. Concentration and market power are thus related but distinct concepts. (oecd.org)
Sources and persistence
Market power becomes more durable when barriers to entry limit the competitive response to profitable opportunities. Such barriers can include substantial unrecoverable investment, regulatory restrictions, access to scarce inputs, and advantages enjoyed by established suppliers. Economies of scale may make entry difficult when a newcomer must achieve substantial output before becoming cost competitive. In a natural monopoly, cost conditions can favor production by a single supplier rather than several smaller ones. (oecd.org)
Other mechanisms affect customers’ ability or willingness to change suppliers. Switching costs can arise from contractual commitments, retraining, or the need to replace complementary equipment. A network effect can strengthen an established product when its value increases with the number of users. These mechanisms may reinforce market power, but their importance depends on available alternatives and how easily customers can use competing products. (oecd.org)
Legal protection can also restrict imitation. A patent may confer exclusive rights over a particular invention, but does not necessarily confer economic monopoly power: competing technologies or products may remain effective substitutes. The relevant question is whether the protection meaningfully weakens competitive constraints. (oecd.org)
Measurement and evidence
A common theoretical measure is the Lerner index:
where is price and is marginal cost. In the standard single-product model, a profit-maximizing firm choosing an interior solution satisfies
where is the price elasticity of demand facing that firm. Less elastic demand permits a larger proportional price–cost margin. This relationship depends on the model’s assumptions and is not a universal rule for every pricing arrangement. (ocw.mit.edu)
Empirical measurement is difficult because marginal cost is rarely directly observed. Accounting profits and gross margins are imperfect substitutes: they may reflect fixed costs, investment, risk, or differences in efficiency. Researchers use econometric methods to estimate demand, costs, and markups, usually combining several indicators rather than treating one statistic as decisive. (oecd.org)
Structural assessment often begins with a relevant market, encompassing products and geographic areas that provide meaningful competitive alternatives. Market shares and concentration measures, including the Herfindahl–Hirschman index, then describe market structure. Their interpretation requires evidence about entry, expansion, customer substitution, and competitive behavior. Internal business documents, customer testimony, and observed responses to price changes can supplement these measures. (justice.gov)
The benchmark matters. If an incumbent already charges a monopoly price, customers’ willingness to substitute at that elevated price may exaggerate the competitive constraint. This problem, known as the Cellophane fallacy, means that observed substitution does not always reveal whether prices are competitive. (justice.gov)
Buyer power
Buyer-side market power is commonly associated with monopsony. It involves the ability to depress payments to suppliers below competitive levels, potentially reducing the quantity supplied. A lower purchase price alone does not establish monopsony power; the analysis concerns diminished competition among buyers and its effects on suppliers’ alternatives. (justice.gov)
In a labor market, employers purchase labor services. Weaker competition among employers may lower wages, slow wage growth, or worsen benefits and working conditions. Job differentiation and frictions in changing employment are relevant because workers may have fewer practical alternatives than the number of employers initially suggests. Buyer-market analysis therefore examines employment options as well as employer concentration. (justice.gov)
Welfare and competition policy
In the standard monopoly model, restricting output raises price and reduces consumer surplus. Some surplus transfers to the seller, while mutually beneficial transactions no longer occur, creating deadweight loss. This allocation problem is one form of market failure. Exclusionary practices can additionally impair efficiency by raising rivals’ costs. (justice.gov)
Competition law distinguishes possessing market power from unlawfully acquiring or maintaining it. In United States monopolization analysis, monopoly power generally denotes significant and durable market power; possession alone is not unlawful. Authorities also evaluate the conduct used to obtain or preserve that position and its competitive effects. Merger review examines whether combining firms may substantially lessen competition, including competition for suppliers or workers. Economic regulation can separately address industries where enduring structural constraints limit competition. (ftc.gov)