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9

Market Power and Monopoly 9

If you were in the market for a tablet computer when the iPad was first introduced, that was your only option. It didn’t even come in a choice of colors.

Apple couldn’t have been happier. It had introduced a fantastically popular product, people were literally lined up ready to buy the iPad, and the company was more or less the only game in town. Other technology companies started rushing their own tablets into production and distribution, but it would take time. It also took considerable persuading to convince many wannabe iPad owners to give up their plans and buy a different product when other tablets became available.

This sort of situation doesn’t fit the perfectly competitive model of a firm’s supply behavior we covered in Chapter 8. In a perfectly competitive market, a firm’s output is so small relative to the total market that its choice of whether or how much to produce does not have a noticeable impact on the total supply in the market. For this reason, a perfectly competitive firm takes the market price of its products as given when making its profit-maximizing production choices. But that was not at all the case for Apple when it introduced the iPad. After all, Apple was the market supply. By adjusting the number of iPads it produced for the market, the firm could cause movements along the market demand curve. If Apple produced only a few iPads, for example, the low quantity supplied would meet the demand curve at a high price, and quantity demanded would also be low. If it produced more, the quantity supplied would equal quantity demanded further down the demand curve, at a lower price. Therefore, Apple’s choice of the quantity of iPads it supplied to the market gave the company effective control over the price at which the iPad sold.

In this chapter, we start to look at firms’ production choices when they have some ability to control the price at which their product sells. A firm that can influence the price its product sells for is said to have market power. The most extreme version of market power is a monopoly, a market that is served by only one firm. Apple basically had a monopoly in the tablet computer market when the iPad first came out. A firm that has a monopoly (a monopolist) has the most market power; for a given market demand curve, its decision about how much to supply completely determines the market price (it’s a price setter). On the other end of the spectrum, firms in perfectly competitive markets are price takers. Because they have no influence over the market price, they have no market power.

As we see in this chapter, firms with market power do not behave in the same way as perfectly competitive firms do. They recognize that their supply decisions will influence the price at which they can sell their output, so such companies take this into account when choosing how much to produce and sell. Perfectly competitive firms don’t have this concern, so they make different output choices. One interesting outcome we learn is that market power can be measured, and that as a firm’s market power falls, its supply behaviors become more and more like those of a perfectly competitive firm. In fact, perfect competition is just a special case of the general model of supply behavior we present in this chapter: When market power falls to zero, a firm that once had market power behaves exactly like a perfectly competitive firm.

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