Market Power

When one thinks of a monopoly today, one thinks of large business or corporation that exercises total control of an industry while often exercising any means necessary to maintain that control. The common thoughts are that no one can stand up to a monopoly, take down a monopoly, and that the effects of a monopoly are destructive to the general welfare. The common conclusion is, therefore, that government should regulate or break up monopolies or companies with “too much” market power wherever they happen to arise. This is, however, a frightfully misguided chain of reasoning that ignores the mechanics of a free market, when such a market exists, that is.

In a free market, the ability of an individual, business, or corporation to compete on the market is not restricted by any government rules, regulations, obstructions, or inhibitions, and nor is any individual, business, or corporation allowed to use force to prevent or discourage others from competing (which is the government’s responsibility to prevent). And so if one thinks of a monopoly that uses practices such as intimidation, threats of physical violence, special government privileges, or bribery of public officials to maintain its monopolistic position, then one is either not thinking about a free market or is thinking about situations which should not exist in a free market and which the institutions present in a free market tend towards eliminating, though there is only so much that can effectively be done at any time to prevent criminal activity in any system.

However, many people will take their objections to monopolies farther and say that monopolies that fit the common conception of a coercive business or corporation that is unchallengeable and destructive to the general welfare will arise even in a free market where no direct force is used against competitors or potential competitors. Many of them therefore think that the government should intervene in these markets in order for the market to even be considered free in the first place. It is not true, however, that market power accumulated in a free market is either unchallengeable or destructive to the general welfare. To see why, one must have a proper understanding of the mechanics of a free market.

And so in order to understand these mechanics, let us first examine a situation in which there are no governmental barriers to competition and also in which there are proper governmental restrictions of the use of force and coercion. For example, no potential entrant in the market can be legally prevented from competing and no business can threaten the entrant with physical force, whether initiated from the business or from the government on the business’s behalf. This is the free market. Now let us suppose that we have a certain industry, and in this industry, let us say that there is a particular firm with a large amount of market power: for example, suppose it has a market share of 80%, meaning that this particular firm sells 80% of the good or service that the industry it is a part of produces. In essence, this firm is a monopoly. Let it also be stated, however, that a company with a high market share does not necessarily decide to raise prices to a monopolistic level, for reasons which should become clear after reading this.

Now, this monopoly can change the price at which it sells its good or service, just like all businesses can. However, because this business has market power, when it changes its prices, the effect is not the same as when a business without market power changes its prices. In a very highly competitive market, when one business raises its prices, consumers can immediately just buy that same good or service from another business for a lower price, and thus by raising its price, that one business has lost money because it has lost all of or nearly all of its sales. When a certain business has a large amount of market power, then the effect is not nearly so powerful, and sometimes a business can profit by raising its prices because the increased amount of profit from its sales outweigh the total loss in the quantity sold. It is for this reason that most people learn in introductory economics that monopolies are “inefficient” compared to a perfectly competitive market, and it is for this reason that market power often makes companies who have it very profitable.

But it is this very profit that works to check the power of a monopoly. Let us say that our supposed business with an 80% market share is raising its prices and also making a lot more profit than it was before it decided to raise its prices. A standard, classical, Econ 101 analysis of monopoly would call this inefficient, because the higher price would discourage potential buyers that the monopoly could have produced for. However, in a free market, competition is free to all comers, and thus, if the monopoly has impacted the market price for a good or service, the monopoly has suddenly created a huge profit potential for potential entrants in their particular market. This potential profit then enables people to get the funds to start their own businesses in the monopoly’s industry and then the new competition drives the price back down to its efficient level. If the price for the good or service in this particular industry is too low, then the lack of profits will drive certain businesses out of the industry letting the remaining ones which were more efficient raise their prices back to where they can continue to make enough money to maintain their businesses.

There is however, still yet another objection to the postulate that a free market can properly deal with monopolies simply through the market process. This particular fallacy is what I call the shortsighted market fallacy with respect to market power (I have never heard anyone else give a name for this fallacy, so I took the liberty for efficiency’s sake), which goes something like this: if competitors try to enter a market in which a monopoly has raised prices higher than they should be, then the monopoly will be able to lower its prices below what prices should be so that none of the competitors can then profit, and will therefore go out of business. Then, because the monopoly has more resources and is more established than the newcomers, it will outlast them, and then the monopoly can raise its prices once again to a higher price than they should be at (the price that “should” exist in the market is determined by an inordinate number of factors, but it is always the price that a free market price tends towards. Simply consider it the “market price”).

This fallacy rests on several false assumptions. The first is that speculators in the market will not react to a large temporal inequality of prices. In other words, when the monopoly lowers its prices below a sustainable level, people who fall for the shortsighted market fallacy do not take into account the huge amount of profit to be made from buying large quantities of what the monopoly produces and then selling these quantities after the monopoly raises the prices back to the very high levels. There are huge gains to be made from taking advantage of this inequality of prices. “Buy in the cheapest market, sell in the dearest” has always been one of the easiest ways to make a profit. This weakens the power of the monopoly by first dramatically increasing its sales when its selling at a price that it cannot sustain and then again by creating a competitive market after the price goes back up, because the price cannot go back to where the monopoly wants it because the speculators begin selling the good the monopoly produces. The other false assumption that this fallacy lies on is that, after the price goes back up to an artificially high monopoly level, the same process of threatened competition resumes because the same profit motive is created. And so for these two reasons, I call this fallacy the shortsighted market fallacy, as it does not take into account the other actions that the supposed actions of the monopoly create and it does not take into account the continuation of time.

Therefore, it cannot accurately be contested that government methods of “anti-trust” are necessary, beneficial, or necessary to call a market “free.” Nor can a free market be opposed on the grounds that monopolies would take it over and destroy the general welfare of the economy. The free market is the best way to handle the issue of prices and market power, because competition will always monitor it and cause it to constantly tend towards the efficient level. And it should also be seen that a company, even with a large market share, will not usually try to raise prices to monopoly levels, even though still pursuing the benefits of selling a large quantity of a good to the market and the efficiency benefits that come from economies of scale.