This is “Regulation to Offset Market Power of Sellers or Buyers”, section 8.4 from the book Managerial Economics Principles (v. 1.0).
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In Chapter 7 "Firm Competition and Market Structure", we considered how monopolies and monopsonies would try to force changes in the price and quantity to move the market to their advantage, but at an even greater cost to the other side of the market. Again, this is not simply an equity concern that one party is getting most of the surplus created by the market (although that may be a legitimate concern) but rather the exertion of market power results in a net loss in total social surplus.
Seller competition is not only helpful in lowering prices and increasing volume and consumer surplus, but firms also compete in terms of product differentiation. When a monopoly or oligopoly emerges and the seller(s) have a sustainable arrangement that generates economic profits, the firms do not have the incentive to spend money in developing better products. The stagnation of the product sold represents another loss in potential value to the consumer.
Unfortunately, monopolies or tight oligopolies can readily develop in markets, especially when there are strong economies of scale and market power effects. For this reason, there are general antitrust laws that empower governments to prevent the emergence of monopolies and tight oligopolies. Some of these laws and regulations actually cite measures of market concentration that can be used as a basis for opposing any buyouts or mergers that will increase market concentration. Where market concentration has already advanced to high levels, firms can be instructed to break up into separate companies. About a century ago, monopolies had developed in important U.S. industries like petroleum, railroads, and electric power. Eventually, the U.S. federal government mandated these monopolies split apart.
As mentioned in earlier chapters, the fact that there are a few large sellers does not automatically constitute abusive use of market power if there is free entry and active competition between sellers. However, if those large sellers collude to hold back production volumes and raise prices, there is a loss in market surplus. The United States has laws that outlaw such collusion. While firms may be able to collude with indirect signals that are difficult for government antitrust units to identify at the time, courts will consider testimony that demonstrates that collusion has taken place.
In Chapter 7 "Firm Competition and Market Structure", we discussed the market power tactics of using low prices to drive out existing competitors and keep out new entrants. When the purpose of the price drop is merely to chase out competition, the practice is labeled predatory pricingThe illegal practice of using low prices for the specific purpose of driving out existing competitors and keeping out new entrants. and is considered illegal. Of course, the firms engaging in price decreases often take the position that they are in a competitive market and are simply competing on the basis of reduced profit margins, just as firms are expected to compete according to the theory of the perfect competition model. Courts are left to determine whether such actions are simply aggressive competition or are intended to create a more concentrated market that allows for greater profits in the long run.
As an alternative to taking actions to limit large firms from exploiting their size, another form of regulation is to encourage more competition by helping small or new competitors. Either subsidies or tax breaks may be offered to help these firms offset the disadvantages of being small in the market and to eventually emerge as an independent player in the market.
In cases where a concentrated seller market exists and the product or service is considered critical to the buyers and the overall economy, the government may decide to intervene strongly by setting a limit on prices or mandating that the product be provided at a minimum quantity and quality.
In situations where there is buyer power, the goal of regulation may be to push prices higher. For example, in agriculture crop markets where the seller farmers often have little market power, but there is concentration on the buyer side, the government will try to keep prices higher by mandating minimum prices or direct assistance to farmers in the form of price support programsA regulation, often used in agricultural markets, through which the government tries to keep prices higher by mandating a minimum price or providing direct assistance to firms that have little market power in the face of buyer concentration..
Another response to market power on one side of the market is to support market power on the other side of the market. Using the crop market example again where there is buyer power, the government has sanctioned the creation of grower cooperatives that control the quantity of the amount sold to processors and thus keep the price higher.