Market Power

Market power describes the capability of either a buyer or a seller to negotiate, bargain, and make exchanges that are more aligned to their own preferences than to the preferences of the other. A market, where goods and services are bought and sold, is a social institution where benefits and costs are distributed. Market power [Page 1344]is the means for market participants to appropriate more benefits for themselves while providing less benefit and transferring more cost to others.

Buyers and sellers negotiate, bargain, and make their exchanges in the market. In a free market, where each exchange is a voluntary transaction between a self-interested buyer and a self-interested seller, buyers or sellers can demonstrate their market power by making credible threats to abandon, or “walk away from,” a bargaining or negotiating interaction. When buyers and sellers can choose whether to enter into agreements, successful exchanges depend on their ability to negotiate terms that satisfy their individual needs.

Explicit communication of a threat to walk away from the exchange is not necessary if one party to the negotiation can recognize the presence of market power without being told. Such recognition, or tacit communication, can arise from patterns in the economic relationships among sellers and buyers. A market relationship in which the seller is dominant may arise from a single, large organization that has a monopoly over supply, or from interorganizational cartel relationships in which several suppliers coordinate their activities to exercise power over smaller and more fragmented buyers. Conversely, a single buyer may be a monopsony or a large organization that accounts for almost all demand. In the absence of monopsony, many smaller buyers may form cooperative relationships to pool their demand and achieve market power over sellers.

Sometimes, market power may be explicitly exercised outside of the direct exchange process. For example, buyers may apply activist techniques that mobilize media, popular opinion, public policy, and other stakeholders to influence the market behavior of suppliers.

For sellers with a surplus of goods and services, unsold products are a cost burden—costs to store the inventory, costs of production equipment not generating revenue, and costs of aging products that may spoil or become obsolete. In this situation, buyers may not need to explicitly threaten sellers in order to exercise market power in negotiations. The relationship of supply and demand motivates sellers to give up their bargaining power so that they can attract relatively scarce buyers for their relatively abundant supply.

Reaching an agreement on a fair price when supply exceeds demand may be an interesting ethical dilemma. If the supplier knows that supply exceeds demand, does honesty require that they inform the potential buyer? If buyers know, is it fair for them to use their market power to demand a price so low that the seller risks going bankrupt? Interestingly, the principle of economic efficiency is yes to both questions. The laws of supply and demand are fundamental engines of free markets, but the engine only works as intended when buyers and sellers have accurate and timely information. Furthermore, society is most productive over the long term when inefficient businesses stop operating and their resources are redeployed to other productive activities. The exercise of market power to serve longterm social progress, however, imposes responsibilities to care for the welfare of those sellers without market power in the short term. Typical examples of such short-term care include public unemployment and retraining insurance.

...