Essay

Market Concentration and Market Power

Maria Williams

Southern New Hampshire University

Market Concentration and Market Power

Market Concentration

Market concentration and market power are two important economic principles. Market concentration is usually used when smaller entities account for a bigger portion of the total market. The Economic Times (2020) defines concentration as the extent at which a smaller number of entities make up for a market’s total production. Thus, market concentration measures the degree of sales domination by one or more entities in a given market. The concentration ratio helps in determining market concentration ratio. Since market concentration ratio determines the total market share of all top companies in an industry, there is a close relationship between competition principle and market concentration.

Market share could represent sales, number of outlets, number of persons using a firm’s services, or employment statistics. The value of top entities can be three or not more than five. If the top companies keep on increasing their market share, then the industry is highly concentrated. Highly concentrated industries are either oligopolistic or monopolistic since only top firms tend to influence production. The Economic Times (2020) indicates that the Herfindahl-Hirschman Index is the most common measure to determining market concentration. The tool calculates market concentration by adding the each individual firm’s square root of percentage market share. Generally, the lower the Herfindahl-Hirschman Index the more competitive the market is.

Market Power

Market power is the ability of an entity to influence the terms and conditions on which products are bought and sold. Kaplow (2017) defines market power as the extent to which a firm can elevate its price above competitive level. A profit maximizing entity with market power is more likely to use its market power in order to charge prices than when an industry is more competitive. In perfectly competitive markets, where rivals offer similar goods and/or services, firms have no market power. If a firm decides to charge a higher price than its competitors, it will lose its market share to cheaper rivals. However, a firm in a monopolistic market can have market power as it can decide to charge a higher price and still enjoy its market share. Firms in perfectly competitive markets can make products more efficiently in order to justify higher markups. The Herfindahl-Hirschman Index also helps in measuring market power, which expresses the sum of squares of each company’s market share in percentage terms.

Applying Market Concentration and Market Power Principles on Healthcare Industry

Hospital markets, without any doubt, have become highly concentrated because of the rising number of mergers and acquisitions. Sari (2008) indicates that more than 40 percent of all healthcare facilities in the United States were involved in mergers and acquisitions between 1994 and 1996. In 1997, more than there were at least 200 mergers. From 1990 to 2003, the United States hospital market concentration increased by approximately 50 percent. By 2003, nearly 90 percent of persons living in larger Metropolitan Statistical Areas experienced highly concentrated markets. The Canadian hospital industry also experienced similar trends during the same period.

Impact of Market Concentration and Market Power Principles on Healthcare Industry

The increase in hospital market concentration may raise significant concerns among decision makers in the health industry due to potential anticompetitive effects of mergers. Profit maximizing firms can exercise market power if there is a decline in the number of rival firms in the market. Nonetheless, mergers can enhance social welfare through efficiency gains associated with economies of scale and scope. Specifically, this can be accomplished through reduction in redundant investments and reductions in management as well as efficiency costs. Sari (2008) posits that as decision makers decide to focus more on the impact of market concentration on pricing and cost efficiency, they are likely to neglect consequences of market concentration on quality of healthcare. Legal changes have also impacted competition in the healthcare industry. In the late 1980s, the United States hospital market, for instance, shifted from non-price competition to intensive price competition because of changes in reimbursement schemes. Sari (2008) asserts that the drastic change in healthcare policy resulted in a shift from patient driven competition toward a payer driven completion. Numerous studies have also sought to investigate the effect of this policy change on costs and pricing within the healthcare industry.

References