Market Power Part 5: Measuring Market Power and the Monopolistic Middle Ground

Market Power Part 5: Measuring Market Power and the Monopolistic Middle Ground

Let’s say you walk down your local high street. There’s a Greggs, a Preta Manger, three different bubble tea spots, and at least four hair salons with puns in their names. None of them dominate the market, but they do have a bit of power. This is the world of monopolistic competition - and it’s more common than you might think.

In our final part of the Market Power series, we look at:

• How economists measure market dominance

• What life looks like between monopoly and perfect competition

• Why big firms can be both helpful and harmful

• How governments step in when power gets out of hand

How Do We Measure Market Power?

Economists don’t just eyeball a market - they crunch numbers. Two key tools help assess market concentration:

1. Concentration Ratios

These show the combined market share of the biggest firms in an industry. For example, if the top 4 firms control 80% of sales, it’s clearly not a competitive free-for-all market.

2. Herfindahl-Hirschman Index (HHI)

This one’s a bit geeky: take each firm’s market share, square it, then add them all up.

• Monopoly (100% share) = HHI of 10,000

• Highly competitive market = lower HHI

• The higher the HHI, the less competition - and the more market power

What Is Monopolistic Competition?

Somewhere between monopoly and perfect competition lies monopolistic competition - a market where:

• There are lots of firms, none dominant

• Products are differentiated (but not wildly so)

• There’s some market power, but not enough to set prices freely

Think:

• Fast food restaurants

• Retail clothing brands

• Local gyms or hairdressers

Each firm can charge a bit more if their product is slightly better, more convenient, or just better marketed. But if they push it too far, customers will simply go elsewhere.

Profits and Pricing in Monopolistic Competition

These firms might earn:

• Abnormal profits (briefly, when they’re popular or new)

• Normal profits (in the long run)

• Or even losses if competition gets fierce

Their demand is price elastic - meaning if they hike prices, they risk losing customers to close substitutes.

And unlike monopolies, these firms can’t rely on massive economies of scale, size or legal barriers to keep competitors out.

Inefficiency in Monopolistic Competition

Bad news: these markets are often allocatively inefficient.

• They don’t produce at the lowest average cost

• They can’t achieve big economies of scale

• Their prices are still above marginal cost

Still, they offer something perfect competition doesn’t: product variety. You get choice - even if it comes at a small efficiency cost.

Market Failure, Information Overload & the Problem of Choice

More options = better, right?

Not always.

Too much choice, misleading marketing, or asymmetric information can lead to market failures in monopolistic competition. Ever spent half an hour on Deliveroo just trying to choose dinner? That’s information overload, not efficiency.

Are Big Firms Always the Bad Guys?

What if large firms with significant market power actually bring some benefits?

The Good News:

• Economies of Scale: Bigger firms produce more efficiently, lowering average costs

• R&D and Innovation: Abnormal profits can fund breakthroughs in tech, medicine, and sustainability

• Infrastructure Growth: Large-scale operations can attract investment, jobs, and improved public services

Internal vs External Economies of Scale:

• Internal: Lower costs from within the firm (e.g. specialisation, bulk buying)

• External: Industry-wide benefits (e.g. improved roads, skilled labour, tech ecosystems)

Natural monopolies (like rail, water, energy) are classic examples where big can be beautiful - if regulated properly.

The Risks of Dominance

But… big firms can also mess things up:

• Underproduction: They restrict supply to push up price (P > MC)

• Overpricing: They exploit price inelastic demand to charge more

• Limited Choice: With no competition, there's little incentive to improve

• Price Discrimination: Charging different customers different prices for the same good, based on PED

That’s why monopolies and oligopolies can lead to market failure - and why regulation exists.

Government Intervention: Playing Referee

Legislation & Regulation

Governments pass laws to:

• Prevent mergers that reduce competition

• Break up cartels or abusive practices

• Set rules for fair pricing

Example: In 2018, Google was fined €4.34 billion by the EU for abusing its dominance in Android markets.

Government Ownership

In some cases, governments nationalise big firms (e.g. railways, postal services) to serve the public interest. It’s expensive, but ensures service over profit.

Fines

The threat of big fines can be a deterrent to anti-competitive behaviour - and can seriously dent a brand’s image if they get caught.

Final Thought: Evaluating Market Power

So - are monopolies and big firms a threat or a blessing?

The answer? It depends.

They can innovate, create jobs, and bring down costs.

But without checks, they can exploit power, limit choice, and cause inefficiencies.

The key takeaway for IB HL Economics? Always consider both sides of market power. Context, behaviour, and regulation matter.

That’s a wrap! You’ve just completed the Market Power series - from perfect competition to monopoly, game theory, and government regulation. Time to celebrate with a profit-maximising coffee cup!

Stay well