Friday, June 10, 2011

Market Power in US Automobile Market

The Financial Times reported that US automobile manufacturers were requiring parts suppliers to lower their prices (called price-downs). This is an excellent example of market power. Market power in economics occurs when the price a firm charges is greater than its marginal cost. This can be achieved conceptually in three ways, One, the firm is able to increase their prices; two, the firm is able to lower their marginal costs, and three a combination of the two.

Practically, this can be though of based on the degree of demand side substitution - the ability of customers to choose different types of products in different product markets, and supply side substitution - the ability of customers to choose different suppliers of products in the same product market.

Here we see an example of the second, the auto firm is able to lower it's marginal cost. But not because the auto firm is increasing its efficiency, but rather because the auto parts firms have limited supply side substitutability. The auto parts firm does not have a lot of options selling auto parts to other auto producers, hence the auto manufacturer has a greater degree of market power.

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