2.11 Market failure - market power

Objective notes

8 learning objectives

2.11.1(HL)—Market structures

• Perfect competition has many firms, free entry, and homogeneous products

• Monopoly has a single or dominant firm, high barriers to entry, and no close substitutes

• Oligopoly has a few large firms, high barriers to entry, and interdependence

• Monopolistic competition has many firms, free entry, and product differentiation

2.11.2(HL)—Rational producer behaviour

• Profit maximization occurs where marginal cost equals marginal revenue

• Profit equals total revenue minus total costs

• Abnormal profit occurs when average revenue exceeds average cost; normal profit when they are equal; losses when average revenue is below average cost

• Calculation [HL]: profit, MC, MR, AC, and AR from data

2.11.3(HL)—Degrees of market power

• Market power is the ability of a firm to influence price

• Perfectly competitive firms have no market power and are price takers

• Imperfectly competitive firms have varying degrees of market power and are price makers

• Diagram: perfectly competitive firm as price taker where P = D = AR = MR

• Diagram: perfectly competitive firm showing abnormal profit, normal profit, and losses

• Diagram: perfectly competitive market equilibrium and allocative efficiency where P = MC or MB = MC

2.11.4(HL)—Monopoly

• Monopoly profit maximization can create allocative inefficiency and welfare loss

• Monopoly may restrict output and raise price compared with perfect competition

• Natural monopoly is a special monopoly case linked to economies of scale

• Diagram: market power where AR exceeds MC

• Diagram: monopolist showing abnormal profit, normal profit, and losses

• Diagram: monopoly versus perfect competition with welfare loss

• Diagram: natural monopoly

2.11.5(HL)—Oligopoly

• Oligopoly can be collusive or non-collusive

• Interdependence creates risk of price war, incentive to collude, and incentive to cheat

• Oligopoly may create allocative inefficiency

• Firms may use price and non-price competition

• Market concentration can be measured using concentration ratios

• Diagram: collusive oligopoly acting as a monopoly

• Diagram: simple game theory payoff matrix

2.11.6(HL)—Monopolistic competition

• Monopolistically competitive firms maximize profit in the short run and long run

• Many substitutes make demand more elastic than monopoly demand

• Monopolistic competition is allocatively inefficient but offers more product variety and less inefficiency than monopoly

• Diagram: monopolistically competitive firm showing abnormal profit, normal profit, and losses

• Diagram: monopolistic competition with more elastic demand than monopoly

2.11.7(HL)—Advantages and risks of market power

• Large firms may gain economies of scale, including natural monopoly efficiencies

• Abnormal profit may fund research, development, and innovation

• Market power risks include lower output, higher prices, and reduced consumer choice

2.11.8(HL)—Government responses to market power

• Governments may use legislation, regulation, government ownership, and fines

• Responses target abuse of significant market power