Strengths & Weaknesses of Market Power

Advantages of Firms Having Significant Market Power (AO3)

• Economies of scale: Usually, as the scale of a firm grows, the per-unit cost of producing a good decreases. This may be due to increased expertise, bigger factories, supplies bought in bulk, etc., all of which lead to greater efficiency. Hence, big market power can be desired in some cases, such as in natural monopolies for example.

• Investment: Abnormal profits firms make could in theory be used for investment into Research & Development (R&D), leading to innovation.

Risks in Markets Dominated by a Few Large Firms (AO3)

• Less output: When firms control the market, they choose to reduce their output compared to the socially optimum quantity in order to maximize profits. This creates a welfare loss.

• Higher prices: Because output is reduced, the market mechanism will make prices increase, and be higher than the socially optimum price.

• Less consumer choice: When there are only a few firms, consumers have less choice of what to purchase. 

So it is quite obvious that while significant market power may cause some benefits, it may also harm consumers. The government could therefore respond in a few ways:

Government Intervention in Response to Abuse of Market Power (AO3)

• Legislation & regulation: The government can prevent firms from becoming too big, by for example blocking big mergers of companies

• Government ownership: Government-owned monopolies can be made so they produce at a socially optimum output rather than at a profit maximizing point, as profits matter less

• Fines: The government can fine large firms for being too big, known as "antitrust"