When market power corrupts

The free market allocates resources efficiently when it works properly. Unfortunately free markets can fail under certain circumstances and one of those is monopoly power. We can define monopoly power as the ability to influence both the price and quantity in a market.

A measure of monopoly power in the concentration ratio. This looks at the market share of the top three, four or five firms in an industry. The higher the share of the market the more power the top firms have.

The three firm concentration ratio for food retailing in Australia is 85%. Coles and Woolworth's have nearly 75% of the market between them (with IGA third). This gives Coles and Woolworth's monopoly power to some extent. (Note a pure monopoly is when a firm has 100% market share, but monopoly power is about the ability to influence customers and suppliers).

When a firm has monopoly power they can work against the best interests of consumers. They can raise prices and so earn higher profits at the expense of customers.

In the article below Woolworth's are accused of using excessive market power to raise profits by abusing their relationship with suppliers. (Technically monopsony power.)

When a firm has such large market share as Woolworth's it is essential for a supplier to have their product on the stores shelves. Imagine you go to Coles or Woolworth and the chocolate bar you wanted wasn't there. You probably buy an alternative that is there.

Woolworth are accused of demanding unfair terms and payments from suppliers in order to raise their profit. They abuse their market power by doing this and the Australian Competition and Consumer Commission (ACCC) are taking them to court.

While this is unusual in that market power is being exploited to reduce suppliers profits it is an excellent example of the work of the ACCC and monopoly power.

The ABC covers the story here

Questions:

1. Why does large market share give a firm monopoly power in a market even though the industry is actually an 'oligopoly'?

2. How does the action of Woolworth's act against the best interests of consumers?

This article is of critical importance to VCE Unit 3. It provides a recent example of the work of the ACCC and the abuse of monopoly power. For IB this is a useful example for the HL section on theory of the firm and policy to correct market failure.