Economies need competition to work. Almost all basic economic theories, including supply and demand itself, rely on the assumption that companies lower prices to undercut the competition whenever possible. If sellers can set whatever prices they like, that’s a monopoly. And as any good Econ 101 class will teach you, monopolies hold production below its economically efficient level, in order to extract extra profits. Monopolies replace the magic of the invisible hand with a distorting visible one, and the economy shrinks as a result.
In the real world, absolute monopolies are very rare. But even if there is more than one company in a given industry, there can be monopoly-like effects if the number of companies is small enough. This is called “oligopoly,” “market concentration,” or “market power.” And it’s something that can be measured fairly easily.
While a few industries have become less concentrated, most of the move is toward oligopoly. That’s good news for the stock performance of the winning companies, but it could be bad for the economy, since oligopolies can limit production in order to push up prices.
Look in the news, and you can see the trend unfolding — as well as attempts to fight it. The drugstore chains Walgreens and Rite-Aid are planning a mega-merger, which they’ve delayed (but not canceled) because of antitrust concerns. Alaska Air and Virgin America are in a similar situation. Chemical giants Dow and DuPont are merging too, despite European concerns. These are only a few examples, but the merger boom has been changing the face of the U.S. economy for years now. Mergers took off in the early 2000s, fell after the financial crisis, and have now rebounded to record levels.
Defenders of mergers often claim that they have a positive effect on efficiency. This is a phenomenon that economists call “economies of scale” — a bigger company can, in theory, lower production costs by reducing fixed costs, standardizing manufacturing processes, combining supply chains and streamlining operations. If these economies of scale are big enough, they could even cancel out the harm done by increasing market concentration.