Final answer:
Market power leads to market failure primarily through decreased market output, which results in higher prices and reduced consumer welfare. It disrupts the competitive equilibrium of the market, leading to inefficiencies and excessive profits for the firm with market power, rather than normalized profits or lower market prices. Hence, option (a) is correct.
Step-by-step explanation:
Market power can lead to market failure when a single firm or a group of firms can influence the market conditions to their advantage, often resulting in a reduction in the overall efficiency of the market.
When market power is significant, it can result in decreased market output because the firm with market power may produce less than what would be offered in a competitive market in order to increase prices and profits. This reduction in output leads to a loss of welfare in the market, as consumer choice is restricted, and prices are typically higher than in a perfectly competitive market.
In stark contrast to normal economic profits, which are expected in a competitive market, market power can lead to excessive profits over what is considered 'normal', indicating that the firms are earning more than the required rate of return. This is often at the expense of consumers and can create a barrier to entry for other potential competitors.
Furthermore, unlike what might be assumed, market power generally leads to higher prices rather than lower, as the firm with market power can set prices above the competitive level.