Market Failure

Market Power

Market power exists when an individual firm has the ability to influence the market price of a good or service with the result that the price exceeds the marginal cost of the good or service. Market power violates the assumption that a sufficiently large number of sellers exists to guarantee that each individual seller is a price taker in a perfectly competitive market. Market power includes situations ranging from imperfect competition, in which multiple sellers compete against each other and each has some influence over the price, to a monopolistic market, in which there is only one seller and this seller has control over the entire market. The presence of market power leads to market failure because of deadweight loss that is, a loss to society due to a market price that is greater than and a market quantity that is less than the market price and quantity in an efficient market.

A classic example of a monopoly in the healthcare market is the market for a drug that is covered by a patent. With a patented drug, only one manufacturer has the legal right to produce the drug until the patent expires, creating a monopoly market until the patent's expiration. As a monopolist, the manufacturer will charge a price that exceeds the efficient price (i.e., the price that would exist in a perfectly competitive market) and sell a quantity of the drug that is less than the efficient quantity.

More commonly, firms may have monopoly power, a situation in which there are multiple sellers of a good or service but one seller can increase its price and still maintain at least some of its market share. Both physicians and hospitals exercise varying degrees of monopoly power. A physician could increase his or her fee for an office visit, for example, and still keep some patients. Whereas some patients may decide to go to a different physician after the fee increase, other patients will remain at the physician's practice. This ability to increase fees without losing all the firm's business is market power. Again, because an efficient market means that sellers are price takers, this is a clear violation of a perfectly competitive assumption.

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