Market power

When firms face the same costs, competition among sellers drives the price of a good down to the production cost of the good, leading to zero economic profits for all competing firms. Any firm that sets the price for its good higher than the competitive price will not sell anything, because customers will go to the firms offering the lower, competitive price. If a firm is able to protect itself against competitive pressures from other firms, it could raise its price higher than the competitive price and secure positive profits for itself.

The implication is that even if there is only one firm in a given market, that firm does not necessarily possess market power. Market power can only exist if there are impediments, called "barriers to entry," that prevent new firms like Sheila's from entering a market and competing on equal terms with firms, like Chris's, already in the market.

Barriers to entry can be divided into two broad categories, those that completely prevent new firms from entering a market, and those that raise the costs of firms that enter a market.

The major barriers to entry confronted by classical economists were government licenses that granted a particular firm or group of firms the exclusive authority to be the only legal seller of a given product.

Governments that were either not aware of or not terribly concerned about the higher prices and lower production that occur under monopolies could sell off a monopoly privilege for substantial revenue because of the high profits that could be generated by a firm with substantial market power.

A temporary form of monopoly granted by governments is the patent.


but many classical and contemporary economists have defended patents as a reward system that generates incentives for innovation.


Other kinds of barriers, which don't totally prevent new producers, but raise their cost to do business in this field.
(1)A local margin monopoly is characterized by the fact that the barrier preventing outsiders from competing on the local market and breaking the monopoly of the local sellers is the comparative height of transportation costs. No tariffs are needed to grant limited protection to a firm which owns all the adjacent natural resources required for the production of bricks against the competition of far distant tile works. The costs of transportation provide them with a margin in which, the configuration of demand being propitious, an advantageous monopoly price can be found.

(2)Other barriers to entry that can raise the costs of firms entering a market are trademarks, brand names, and advertising.The basic argument is that if a product becomes well-known and for whatever reason inspires a certain amount of brand loyalty from its consumers, then those consumers will be willing to pay more than the competitive price for the good, even if a cheaper alternative exists.

Since Knight and Mises wrote on the subject, many economists have come to the conclusion that the main impact of advertising is to improve rather than deter competition, by increasing the amount of information available to consumers.

Barriers to entry that arise due to geographic considerations (transportation costs) or the spending decisions of the producing firms themselves (advertising, brand names, etc.) are only able to impute some additional costs to firms that want to enter a market. Barriers that completely prohibit new firms from entering typically arise on government authority.

Differences between these two kinds of monopolies 
(1) The degree of market power afforded to firms by distance or brand loyalty is likely to be fairly limited. A firm possessing these types of market power still cannot raise its price so high that it becomes feasible for competitors to incur substantial transportation costs, or for loyal consumers to be enticed away from their normal brand to a significantly cheaper rival.

(2) Market power arising outside of the government can be reduced outside of the government. Improvements in the speed, reliability, and safety of transportation lower transportation costs and force a holder of a local margin monopoly to bring his price closer to the competitive price. Development in communication technologies creates new opportunities to target potential customers and establish a new brand's identity. Market power bestowed by an act of government, on the other hand, can usually only be removed by another act of government.