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  • Print publication year: 2004
  • Online publication date: August 2015

2 - Market Power and Welfare: Introduction

Summary

OVERVIEW OF THE CHAPTER

The basis of competition policy is the idea that monopolies are “bad”. Indeed, Section 2.2 shows that a monopoly causes a static inefficiency: for given technologies, monopoly pricing results in a welfare loss. Further, there generally is an inverse relationship between market power (the ability of firms to set prices above marginal costs), of which monopoly power is the most extreme form, and (static) welfare.

Sections 2.3 and 2.4 show that by looking only at allocative inefficiency one might actually underestimate the welfare loss from market power. A monopoly (more generally, high market power) might also result in productive and dynamic inefficiencies. Not only does a monopolist charge too high a price, but it might also have too high costs and innovate too little, since – sheltered from competition – it is not pushed to adopt the most efficient technologies and to invest much in R&D.

One might be tempted to conclude that if having one firm (or very few firms) leads to welfare losses, then competition policy should try to increase the number of firms, which operate in the industry (for instance subsidising and protecting less successful firms). Section 2.3 shows that such a conclusion would not be correct, because keeping less efficient firms artificially alive would distort the allocation of resources and reduce economies of scale, thus reducing welfare. In short: (1) competition policy is not concerned with maximising the number of firms, and (2) competition policy is concerned with defending market competition in order to increase welfare, not defending competitors.

Although there is an inverse relationship between market power and welfare under static analysis, it is not clear that the same unambiguous relationship exists when productive and dynamic inefficiencies are considered. In any event, Section 2.4 argues that market power is certainly not per se bad. Indeed, the prospect of enjoying some market power (and profits) is the main incentive for firms to invest and innovate.

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