Calculating Market Power

Question 1

Herfindal-Hirschman Index

Answer 1

• ## the closer a market is to monopoly, the higher the market’s concentration –> and the lower its competition

Question 2

Market Concentration

Answer 2

• a function of the number of firms and their respective shares of the total production in a market
• is a way to quantify the structure of a market

Question 3

Market Power

Answer 3

• ability of a firm to raise its price over marginal cost

- strength of competition and the number of constraints placed on firms

Question 4

Signs of MP

Answer 4

• an increase could dictate a decline in competition
• it could equal reflect the forces of competition in action, bring success and market share to more efficient firms

Output:
- when competitive intensity falls/market power increased –> output levels should be lower than normal –> prices are higher than normal

Mark Ups and Profits

• the extent to which price exceeds marginal cost
• increase in mark-up –> a firm’s market power has increased

Churn:
- changes in the rate of entry/exit (churn) of firms across the economy as a whole

Other:
- a reduction in competitive intensity is the cause of changes in measures such as corporate investment and the labour share of income

Question 5

What drives these changes

Answer 5

Causes:

- those in which firms that have gained market power have earned it through

Question 6

Barriers to Entry

Answer 6

• obstacles that make it difficult to enter a given market
• can be erected deliberately –> strategic/artificial barriers –> advertising, branding, loyalty schemes
• can be natural/structural –> economics of scale, high set-up costs, high RnD costs

Question 7

Economics of Scale

Answer 7

• large firms are more efficient that small ones because they can gain from economic of scale –> firms can become too large and suffer from diseconomies of scale
• lowers point on the long run average cost curve

Question 8

Technical Economics

Answer 8

• cost savings a firm makes as it grows larger and arise from the increased use of large-scale mechanical processes and machinery

Question 9

Network Effects

Answer 9

• the effect that multiple users have on the value of a g/s to other users
• E.G –> spread of popularity of the phone/social media –> strong network effects

Question 10

Ownership of a key scarce resources

Answer 10

• owning scarce resources, which other firms could use creates a considerable barrier to entry
• an airline controlling access to an airport

Question 11

High Set-Up costs

Answer 11

• these deter initial market entry

- sunk costs –> cannot be recovered when a firm leaves a market

Question 12

Predatory Pricing

Answer 12

• firms deliberately lowering a price to force rival firms out of the market

Question 13

Predatory Acquisiton

Answer 13

• taking over a potential rival by purchasing sufficient shares to gain a controlling interest or complete buy-out

Question 14

Switching Costs

Answer 14

• costs incurred by a consumer when trying to switch suppliers
• common when switching energy suppliers, banks, TV and telephone suppliers
• may be structural in nature –> referred to as strategic barriers

Question 15

Others

Answer 15

• Advertising - sunk costs
• A strong brand - locks in existing customers and deters entry
• Loyalty schemes - retain customer loyalty
• Exclusive contracts/patents/licenses –> entry is difficult –> existing firms are protected who have won the contract, or own the license/patent
• Vertical Integration

Question 16

Contestable Market

Answer 16

• a market where the credible threat of new entrants exerts discipline over incumbent providers in their market behaviour
• persistent influx over time of new entrants in a market is evidence of contestability –> credible threat of entry can have a positive impact on competition