CHAPTER 14 Market Structure and Market Power

It all started in Steve Jobs’ garage.

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Chapter Objective

Learn how to set prices when you have market power.

• 14.1 Monopoly, Oligopoly, and Monopolistic Competition

  Evaluate how market structure shapes the market power your business has.

• 14.2 Setting Prices When You Have Market Power

  Calculate the best price to set when you have market power.

• 14.3 The Problem with Market Power

  Assess how market power distorts market forces.

• 14.4 Public Policy to Restrain Market Power

  Assess policies to limit the problems caused by market power.

The story begins with a 21-year-old named Steve fooling around with electronics in his parents’ garage. Eventually, Steve decided to get serious about building computers, and so he and his pals started a company. He was experimenting with a fruitarian diet, so perhaps it’s no surprise that he decided to call their company Apple. That garage-built business went on to become the first company to be worth more than $1 trillion. It’s more valuable than Samsung, IBM, and HP combined. What makes Apple so profitable?

Popular accounts focus on Steve Jobs’ obsessive perfectionism, his drive for innovation, his vision, and his commitment to designing beautiful objects. Perhaps. But maybe the most important factor was that Jobs really understood economics, and he used that to guide his strategic decisions.

Crucially, Jobs focused his strategy on starting and dominating new markets, rather than trying to compete against existing businesses. Take the iPhone: This innovation essentially started the smartphone market. Today, Samsung, Motorola, and HTC all compete to make Android phones, but only Apple makes the iPhone. Something similar happened with tablets, where the innovation of Apple’s iPad led Apple to dominate the tablet market. Even though companies that compete to make Android tablets have gained ground, only Apple sells the iPad. Likewise, Lenovo, Dell, and HP all compete to make Windows computers, while if you want to use macOS, you have to buy an Apple computer.

The result is that Apple faces fewer direct competitors, which allows it to raise prices and enjoy healthy profit margins. By this telling, much of Apple’s success comes from developing and exploiting market power.

This chapter is all about understanding the structure of competition in your market, and how it shapes your market power and pricing strategies. Along the way, we’ll see how it can become important for the government to intervene, to protect the forces of competition.