HERFINDAHL INDEX: A measure of concentration of the production in an industry that's calculated as the sum of the squares of market shares for each firm. This is an alternative method of summarizing the degree to which an industry is oligopolistic and the relative concentration of market power held by the largest firms in the industry. The Herfindahl index gives a better indication of the relative market control of the largest firms than can be found with the four-firm and eight-firm concentration ratios.
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The ability of buyers or sellers to exert influence over the price or quantity of a good, service, or commodity exchanged in a market. Market control largely depends on the number of competitors on each side of the market. If a market has relatively few buyers, but many sellers, then limited competition on the demand-side of the market means buyers tend to have relatively more market control than sellers. The converse occurs if a market has many buyers, but relatively few sellers. This is also termed market power. Market control is the ability of buyers or sellers to influence the price, quantity, or other aspects of a market. The number of competitors is the key determinant of market control. More competitors mean less market control and fewer competitors mean greater market control.
Buyers with market control face a negatively-sloped demand curve. Buyers with no market control face a horizontal or perfectly elastic demand curve at the market price. Sellers with market control face a positively-sloped supply curve. Sellers with no market control face a horizontal or perfectly elastic supply curve at the market price.
Market control is a key source of inefficiency. With market control profit-maximizing firms do not equate demand price and supply price. As such, the value of goods produced is not equal to the value of goods not produced. Society's overall satisfaction can be increased by producing more of one good and less of another good.
Price Takers and MakersMarket control, or lack thereof, underlies two types of market participants--price takers and price makers.
- Price Takers: These are participants with no market control. They can do nothing but "take" the going market price. Price-taking sellers sell all of their output that they want at the existing market price. Price-taking buyers can buy all of the good that they want at the existing market price. Price takers are also called price seekers.
- Price Makers: These are participants with some market control. They are able to "make" the market price, that is, to set the price. Price-making sellers can select from a range of prices, and in so doing, affect the quantities that buyers are willing to purchase. Price-making buyers can also select from a range of prices, and in so doing, affect the quantities that sellers are willing to sell. Price makers are also called price setters.
Market StructuresMarket control among either buyers or sellers gives rise to an assortment of market structures.
- Perfect Competition: The benchmark is perfect competition, an extreme, idealized market structure in which participants have absolutely NO market control. Firms operating in this market structure epitomize price takers. However, perfect competition does NOT exist in the real world in its purest, most perfect form. The real world contains market structures with varying degrees of market control.
- Monopoly/Monopsony: In direct contrast to perfect competition are monopoly and monopsony. Monopoly is a market with a single seller that has total market control over the supply-side of the market. Monopsony is a market with a single buyer who has total market control over the demand-side of the market.
- Oligopoly/Oligopsony: Oligopoly is a market with a small number of large sellers, with each having a significant degree of market control. Oligopsony is a market with a small number of large buyers, with each having a significant degree of market control.
- Monopolistic/Monopsonistic Competition: Monopolistic competition is a market with a large number or small sellers, each with some market control of the selling side, but not a lot. Monopsonistic competition is a market with a large number or small buyers, each with some market control of the buying side, but not a lot.
Not Complete ControlMarket control does not mean a buyer or seller can establish any price AND any quantity. A monopoly seller, for example, can select EITHER the price OR the quantity, but not both. It controls supply, but it is constrained by the demand curve. If the monopoly seller establishes a particular price, then buyers decide the quantity purchased based on their willingness and ability to buy and the law of demand. If the monopoly seller establishes a particular quantity, then the buyers decide the price that they are willing and able to pay.
Alternatively, a monopsony can establish EITHER the price OR the quantity, but not both. It controls demand, but it is constrained by the supply curve. If the monopsony buyer establishes a particular price, then sellers decide the quantity offered for sale based on the law of supply and their willingness and ability to sell. If the monopsony buyer establishes a particular quantity, then the sellers decide the price that they are willing and able to accept.
Sources of Market ControlTwo key sources of market control are the availability of close substitutes and barriers to entry. Market control among sellers is greater if buyers have fewer substitutes from which to choose. The availability of substitutes depends on the barriers other firms face to enter the market.
A monopoly, in particular, has a great deal of market control because it sells a good with very few close substitutes. Anyone seeking the product must buy from the monopoly. The monopoly is then able to maintain market control due to barriers to entry. These are assorted legal and economic obstacles that make it difficult, if not impossible, for competing sellers to entry the industry. Entry barriers prevent other firms from making close substitutes available to buyers.
Other market structures, oligopoly or monopolistic competition, have less market control because entry barriers are not as great or buyers have access to a larger number of substitutes.
The Inefficiency of Market ControlThe primary problem with market control is inefficiency. Compared to the ideal benchmark of perfect competition with no market control, market control prevents the efficient allocation of resources.
The key criterion for efficiency is equality between price and marginal cost, also stated as equality between the value of the good produced and the value of goods not produced.
- Market control on the supply-side (monopoly, oligopoly, and monopolistic competition) means that sellers face negatively-sloped demand curves, which creates a gap between marginal revenue and price. As such, when profit-maximizing firms equate marginal revenue and marginal cost, they fail to equate price with marginal cost.
- Market control on the demand-side (monopsony, oligopsony, and monopsonistic competition) means that buyers face positively-sloped supply curves, which creates a gap between marginal factor cost and price. As such, when profit-maximizing firms equate marginal revenue product and marginal factor cost, they fail to equate price with marginal revenue price.
MARKET CONTROL, AmosWEB Encyclonomic WEB*pedia, http://www.AmosWEB.com, AmosWEB LLC, 2000-2024. [Accessed: March 4, 2024].
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