How can a dominant firm manipulate the market price?

A dominant firm can manipulate the market price by controlling the supply of a product or service.

A dominant firm, often a monopoly, has significant market power. This means it can influence the price of a product or service by controlling its supply. If the firm decides to reduce the supply of a product, the price will likely increase due to the law of supply and demand. Conversely, if the firm increases the supply, the price may decrease. This ability to manipulate price is a key characteristic of a dominant firm and is often seen as a form of market failure.

One way a dominant firm can manipulate the market price is through predatory pricing. This involves setting prices very low, often below cost, to drive competitors out of the market. Once the competition has been eliminated, the firm can then raise prices significantly. This strategy can be very effective, but it is also risky and can lead to legal challenges as it is considered anti-competitive behaviour.

Another strategy is price discrimination, where the firm charges different prices to different consumers for the same product or service. This can be based on factors such as location, time of purchase, or consumer characteristics. Price discrimination allows the firm to extract maximum consumer surplus and increase its profits.

A dominant firm can also engage in limit pricing, where it sets the price low enough to deter potential entrants into the market. This price is still high enough for the firm to make a profit, but low enough to make it unattractive for new firms to enter the market. This strategy helps the dominant firm maintain its market power and continue to control prices.

In some cases, a dominant firm may also engage in price leadership, where it sets the price that other firms in the market follow. This can lead to a form of tacit collusion, where firms implicitly agree to maintain high prices rather than competing on price. This strategy can be effective in industries with a few large firms, but it can also lead to anti-competitive behaviour and market failure.

In conclusion, a dominant firm can manipulate the market price in several ways, including controlling supply, predatory pricing, price discrimination, limit pricing, and price leadership. These strategies can increase the firm's profits and market power, but they can also lead to market failure and are often subject to legal and regulatory scrutiny.