Introduction to Part III: Sources of market power

Consider the banking deposit market. If you have some savings, you are most probably one of the many agents active on the supply side of this market. Indeed, on this market, households and non-financial firms supply deposit funds, banks demand these funds and an interest rate plays the role of price. Even if banks are on the demand and not on the supply side, it only requires a little bit of imagination to apply the insights of Chapter 3 to analyse how banks compete for deposit funds. In particular, following the prediction of the Bertrand model, we can expect that if deposits are a homogeneous product, price competition among banks will drive the deposit rates that banks pay up to the loan rates that they charge, thereby eliminating their intermediation margin and their profits. It appears, however, that this prediction does not correspond to the reality: banks do manage to secure a positive intermediation margin and can therefore be said to possess market power.

In this part of the book, we want to understand where market power comes from, be it in the banking sector or in any other oligopolistic market. As we will see, market power may result from the conduct of the firms and/or from the environment of the market. Starting with firms' conduct, we describe how market power results from a well-blended marketing mix.