Unit 7 The firm and its customers

7.12 Influencing market power, and competition policy

Section 7.7 showed that when a firm charges a price above the marginal cost of production, the market outcome is not Pareto efficient and there is a deadweight loss. Market power may come from cost advantages or strategies to differentiate a product significantly from rival products. Research by economist Jan Eeckhout and his colleagues shows that there has been a steady increase in market power since the 1980s, with damaging effects on society. He argues that we urgently need to increase competition.

competition policy, antitrust policy
Government policies and laws to limit market power and prevent cartels, or to otherwise regulate the process of competition, are collectively known as competition policy or antiitrust policy.

Government policy to reduce market power and encourage competition is known as competition policy or antitrust policy. Competition authorities investigate cases where there is a concern that consumer and wider benefits from competition are lower than what is potentially feasible, because firms are limiting the scope for rivals in their market. This will normally arise in markets where one or a few dominant firms have high market share. But they only intervene if they conclude that firms have the ability and incentive to abuse their market power.

Firms may be able to influence both rivalry and elasticity of demand, limiting the extent of competition. A UK grocery market investigation in 2008 found that supermarkets had intentionally prevented other retailers from expanding or entering markets by buying up land and leaving it unused so that it was not available to others, and recommended that such behaviour should be prevented through changes to the planning laws.

Firms can exclude rivals by limiting their access to production inputs. In 2014, Ferrero, a market leader in chocolate confectionery, became the world’s largest producer of hazelnuts (a key ingredient of its product, Nutella) when it acquired one of its suppliers, Oltan. In this case, the European competition authorities approved the acquisition, arguing that there were enough other hazelnut suppliers to provide competition.

Patents and intellectual property rights also provide exclusive rights to an input to production—ideas. Patents incentivize R&D by providing temporary market power to a firm. Once they come to an end, we expect rival firms to enter the market. In the pharmaceuticals industry, generic drugs can be produced when patents have run out, leading to scope for competition after a period of time.

You can find out more about how competition in digital markets is analysed by competition policy economists in the CORE Econ Digital Markets Insight (forthcoming in 2024).

Limiting rival firms’ access to consumers is also exclusionary behaviour. Microsoft was investigated by US and EU antitrust authorities for preventing web browsers from being uploaded to their Windows operating system, so that rival software developers, such as Netscape, couldn’t reach a significant customer base.1 After years of investigation, resulting in changes to Microsoft’s business model and millions of dollars in fines, a browser market developed. But Figure 7.27 shows that competition is dynamic: Google Chrome now has significant market power. Competition policy is often playing catch-up.

In this line chart, the horizontal axis shows years from 2009 to 2023. The vertical axis shows the worldwide market share of several Internet browsers. In general, the share of Internet Explorer, Firefox, Safari, Opera, Android, UC browser, Samsung Internet, Edge Legacy converged to a range between 0% and 4% from 2017 onwards. Other browsers’ share increased from 5% in 2011 to around 15% in 2021. Chrome’s market share increased from 10% in 2011 to around 60% in 2021.

Figure 7.27 Browser market share worldwide, 2009–2022.

This website contains an infographic of the firms that Meta (Facebook) has acquired over the past few decades.

Another way to reduce rivalry is by merging with other firms. Meta (Facebook) increased their market power across an ecosystem of products by buying other companies, including Instagram and WhatsApp. Competition authorities investigate potential harms from such mergers, but in some cases have found that the lower cost and consumer benefits from economies of scale, economies of scope, and network economies outweigh potential competition concerns. Economists argue that competition authorities need to consider wider economic effects from allowing such mergers.

Colluding with other firms by forming a cartel has a similar effect to a merger, with firms agreeing to behave like a monopoly. Cartels are illegal under most countries’ competition laws, but are difficult to prove. You can learn more about dynamics of oil prices, and the impact of OPEC, one of the most famous cartels, in Section 8.8.

Major cereal brands pay retail shops to dominate the cereal aisles, and companies pay Google to show up first in an online search. Many customers own more than one Apple product. Switching to an Android phone from an iPhone is less attractive if it reduces connectivity across your devices.

A firm can also gain market power by making its customers less price-sensitive, for example, by using advertising to strengthen a brand, influencing product placement, or creating interconnected products.

For a detailed discussion, read the CORE Econ Insight on Digital Markets (forthcoming in 2024). The development of digital market regulation proposals in different countries is described in this December 2021 report from the OECD.

Competition authorities need to assess all the potential harms and benefits of firms’ strategies on a case-by-case basis. In the case of natural monopolies, where there are cost advantages of very large scale, the appropriate policy response may be close regulation of prices or, in some cases, public ownership. Platform companies are proving a dilemma for policymakers, with natural monopoly-like characteristics due to scale and network effects, alongside competition with many advertisers and retailers using the platforms to reach customers. Debates continue about how they should be regulated.

Exercise 7.6 Market power and competition policy in digital markets

Read this interview on competition issues in digital markets. Use this information to answer the following questions:

  1. What unique challenges do digital markets pose to competition policy? (You may find it helpful to think about how firms that operate in digital markets or the products they offer differ from the ‘traditional’ firms we’ve discussed in this unit.)
  2. What kinds of measures are authorities undertaking to regulate firms’ behaviour in digital markets? How do these measures differ from the approaches taken to regulate firms’ behaviour in non-digital markets?

Question 7.15 Choose the correct answer(s)

Suppose that in a small town, a multinational retailer is planning to build a new superstore. Which of the following arguments could be correct?

  • The local protestors argue that the close substitutability of some of the goods sold between the new retailer and existing ones means that the new retailer faces inelastic demand for those goods, giving it excessive market power.
  • The new retailer argues that the close substitutability of some of the goods implies a high elasticity of demand, leading to healthy competition and lower prices for consumers.
  • The local protestors argue that once the local retailers are driven out, there will be no competition, giving the multinational retailer more market power and driving up prices.
  • The new retailer argues that most of the goods sold by local retailers are sufficiently differentiated from its own goods that their elasticity of demand will be high enough to protect the local retailers’ profits.
  • The availability of close substitutes implies elastic demands for those goods.
  • Close substitutability between goods implies competition between providers, which typically results in lower prices.
  • If the local retailers are driven out, the multinational will have more market power. It will face less elastic demand, and be able to raise prices without losing customers.
  • High differentiability (low substitutability) implies less elastic demand.
  1. Richard J. Gilbert and Michael L. Katz. 2001. ‘An Economist’s Guide to US v. Microsoft’. Journal of Economic Perspectives 15 (2): pp. 25–44.