Prices Falling to Costs

In a competitive industry, when firms lose their market power prices must eventually fall to costs. This is because all firms become price takers – no single firm has sufficient market power to influence pricing. As prices fall to costs, profits are driven to zero and firms exit the industry seeking greater returns elsewhere. This is the dynamic of a perfectly competitive market.

In an imperfectly competitive market, failure to gain market power is a failure to compete. When a firm fails to gain market power, or relinquishes any that it has, it is prima facie evidence of competitive failure.

Market power results from offering superior and differentiated value that translates into consumer surplus. Market power is a function of advantages – the particular sets of resources and capabilities that a firm develops to create value. The more asymmetrical a firm’s advantages are from rivals, the more distinctive and powerful they are. Powerful advantages result in greater market power, and through this a firm is able to set its pricing. Asymmetric advantages are the key that unlocks market power.

Advertisements

Leave a Reply

Fill in your details below or click an icon to log in:

WordPress.com Logo

You are commenting using your WordPress.com account. Log Out / Change )

Twitter picture

You are commenting using your Twitter account. Log Out / Change )

Facebook photo

You are commenting using your Facebook account. Log Out / Change )

Google+ photo

You are commenting using your Google+ account. Log Out / Change )

Connecting to %s