Market Power: Imperfect Competition and Strategic Behavior

Previous chapters used the principles of economics to build analytical models of individual choice and market outcomes designed to explain and predict changes in price, quantity and wellbeing in response to a change in circumstances. Each model shows how economic principles would apply to one type of situation, using prior knowledge of the context to show how supply, demand and trade respond to policy interventions that alter the distribution and level of wellbeing, first in the benchmark case of perfect competition and then with externalities that drive change in sustainability and equity. This chapter introduces the concept of market power, which is when a single seller or buyer controls the entire quantity bought and sold. In the first section we explore how firms acquire market power through economies of scale and product differentiation, how firms use market power to raise profits through quantity restriction or price discrimination and how governments respond in ways that alter market outcomes. In the second section we show how economic principles apply to strategic interactions, introducing game theory through the example of two people each of whom chooses between two options. That example shows how each person’s choices, when taking the other’s responses into account, lead to outcomes that depend on the payoff matrix of potential outcomes. The chapter provides many examples of how market power and strategic interactions play out in the food system, showing how economic analysis can help decision-makers reach higher levels of efficiency, equity and sustainability.