IB Economics HL 2.11 Market Failure Market Power

[Maximum number: 25]

(a)

Distinguish between perfect competition and monopolistic competition.

[ 10 ]

(b)

Using real-world examples, discuss the impact of large firms having significant market power.

[ 15 ]

Answers may include:
- Terminology: market power
- Explanation: of the impact of significant market power in terms of the monopoly and oligopoly models
- Diagram: showing monopoly/collusive oligopoly (significant market power)
- Synthesis (discuss): the advantages and disadvantages of significant market power in terms of economies of scale, including natural monopolies, abnormal profits to finance investment in R&D and innovation;
the possible welfare loss, the risks in relation to price, output and consumer choice, the possibility that such firms may pursue goals other than profit maximization
- Examples: real-world examples of large firms that have significant market power.

Examiners should be aware that candidates may take a different approach which, if appropriate, should be rewarded.
N.B. It should be noted that definitions, theory and examples that have already been given in part (a), and then referred to in part (b), should be rewarded.

Assessment Criteria

Marks ..... Level descriptor
0:
- The work does not reach a standard described by the descriptors below.
1-3:
- The response indicates little understanding of the specific demands of the question.
- Economic theory is stated but it is not relevant.
- Economic terms are stated but they are not relevant.
- The response contains no evidence of synthesis or evaluation.
- A real-world example(s) is identified but it is irrelevant.
4-6:
- The response indicates some understanding of the specific demands of the question.
- Relevant economic theory is described.
- Some relevant economic terms are included.
- The response contains evidence of superficial synthesis or evaluation.
- A relevant real-world example(s) is identified.
7-9:
- The response indicates understanding of the specific demands of the question, but these demands are only partially addressed.
- Relevant economic theory is partly explained.
- Some relevant economic terms are used appropriately.
- Where appropriate, relevant diagram(s) are included.
- The response contains evidence of appropriate synthesis or evaluation but lacks balance.
- A relevant real-world example(s) is identified and partly developed in the context of the question.
10-12:
- The specific demands of the question are understood and addressed.
- Relevant economic theory is explained.
- Relevant economic terms are used mostly appropriately.
- Where appropriate, relevant diagram(s) are included and explained.
- The response contains evidence of appropriate synthesis or evaluation that is mostly balanced.
- A relevant real-world example(s) is identified and developed in the context of the question.
13-15:
- The specific demands of the question are understood and addressed.
- Relevant economic theory is fully explained.
- Relevant economic terms are used appropriately throughout the response.
- Where appropriate, relevant diagram(s) are included and fully explained.
- The response contains evidence of effective and balanced synthesis or evaluation.
- A relevant real-world example(s) is identified and fully developed to support the argument.

[Maximum number: 13]

The following diagram illustrates the demand and cost conditions of a firm.

(a)

Identify whether this firm is in perfect competition. You must give a reason for your choice.

[ 2 ]

(b)

Identify the profit maximizing level of output for this firm. You must give a reason for your choice.

[ 2 ]

(c)

Calculate the total revenues and the total costs and the profits or losses for this firm at the profit maximizing level of output.

[ 3 ]

$\mathrm{TR}=\$ 20.00 \times 17000=\$ 340000$ $\mathrm{TC}=\$ 11.00 \times 17000=\$ 187000$

Profit $=\mathrm{TR}-\mathrm{TC}=\$ 340000-\$ 187000=\$ 153000$ of profits

Marking guidance:

OFR applies for the third mark.
Workings are not required for any of the responses.
If the dollar sign is not present in each of the three steps then a maximum of 2 marks may be awarded.

(d)

Identify the level of output this firm would choose if instead of profit it aimed at maximizing revenues. You must give a reason for your choice.

[ 2 ]

(e)

Explain why a profit maximizing firm with monopoly power will never choose to operate on the inelastic portion of its average revenue curve.

[ 4 ]

[Maximum number: 25]

(a)

Explain how welfare loss may result from monopoly power.

[ 10 ]

(b)

Discuss the effectiveness of government policies (legislation and regulation) to reduce monopoly power.

[ 15 ]

N.B. It should be noted that definitions, theory and examples that have already been given in part (a), and then referred to in part (b), should be rewarded.

Answers may include:
- definitions of monopoly power and legislation (anti-monopoly, anti-collusion, merger prevention etc.) and regulation (lower prices and larger quantities for consumers, fair prices for natural monopolies)
- theory of how a monopolist's control of price or output might be reduced by legislation or regulation in the interests of the consumer
- diagram to show a comparison of monopoly and perfect competition;
diagram to illustrate price regulation showing monopoly charging a price which is equal to average cost
- examples of legislation, regulation, and also other solutions such as nationalization, privatization and trade liberalization
- synthesis and evaluation (discuss).

Discussions may include: effectiveness of policies against the sources of monopoly power, eg reduction of legal barriers to entry, control of anti-competitive behaviour. Where natural monopoly occurs, restrictive policies might not be in the consumer's interest. Government policies might be rendered less effective by globalization. Government policies might move a market from monopoly towards a market structure which gives rise to allocative efficiency.

Examiners should be aware that candidates may take a different approach which, if appropriate, should be rewarded.

Opinions or conclusions should be presented clearly and should be supported by appropriate examples.

Assessment Criteria

Part (b) 15 marks
0 The work does not reach a standard described by the descriptors below. ..... 0
1 There is little understanding of the specific demands of the question.
Relevant economic terms are not defined.
There is very little knowledge of relevant economic theory.
There are significant errors. ..... 1-5
2 There is some understanding of the specific demands of the question.
Some relevant economic terms are defined.
There is some knowledge of relevant economic theory.
There are some errors. ..... 6-9
3 There is understanding of the specific demands of the question.
Relevant economic terms are defined.
Relevant economic theory is explained and applied.
Where appropriate, diagrams are included and applied.
Where appropriate, examples are used.
There is an attempt at synthesis or evaluation.
There are few errors. ..... 10-12
4 There is clear understanding of the specific demands of the question. Relevant economic terms are clearly defined.
Relevant economic theory is clearly explained and applied.
Where appropriate, diagrams are included and applied effectively.
Where appropriate, examples are used effectively.
There is evidence of appropriate synthesis or evaluation.
There are no significant errors. ..... 13-15

[Maximum number: 10]

Distinguish between perfect competition and monopolistic competition.

[Maximum number: 10]

Using a diagram, explain how a firm in perfect competition can be making losses whilst still producing at the level of output where marginal costs equal marginal revenue.

[Maximum number: 10]

Explain how welfare loss may result from monopoly power.

[Maximum number: 10]

Explain why a firm in an oligopoly market structure might collude with other firms in the same market.

[Maximum number: 10]

Using at least one diagram, explain how firms operating in monopolistic competition will make normal profit (zero economic profit) in the long run.

Candidates may include:
- a definition of long run
- a definition of normal profit (zero economic profit)
- an explanation of the characteristics of firms in monopolistic competition
- an explanation of the short run profit maximizing output of a firm operating in monopolistic competition, with the firm making either abnormal profit or loss
- an explanation of how free entry in the long run, will result in a leftward shift in the demand curve facing the monopolistically competitive firm when existing firms are making abnormal profit in the short run
- an explanation of how free exit in the long run, will result in a rightward shift in the demand curve facing the monopolistically competitive firm when existing firms are making losses in the short run
- an explanation of how free entry/exit would lead firms in monopolistic competition to make normal profit in the long run
- use of a diagram showing the abnormal profit/loss of monopolistically competitive firms in the short run
- use of a diagram showing the long run equilibrium where the firm earns normal profit
- examples of monopolistically competitive firms.

Candidates need not examine both abnormal profit and loss scenarios;
an explanation of one or the other is enough for full marks.

Examiners should be aware that candidates may take a different approach which if appropriate, should be rewarded.

Assessment Criteria
0 Completely inappropriate answer. ..... 0
1 Little understanding of the specific demands of the question. Very little recognition of relevant economic theory. Relevant terms not defined.
Significant errors. ..... 1-3
2 Some understanding of the specific demands of the question. Some recognition of relevant economic theory. Some relevant terms defined.
Some errors. ..... 4-6
3 Understanding of the specific demands of the question.
Relevant economic theory explained and developed. Relevant economic terms defined.
Few errors.
Where appropriate, diagrams included. ..... 7-8
4 Clear understanding of the specific demands of the question. Relevant economic theory clearly explained and developed. Relevant economic terms clearly defined. No major errors.
Where appropriate, diagrams included and explained.
Where appropriate, examples used. ..... 9-10

[Maximum number: 15]

Using real-world examples, discuss whether firms with significant market power are desirable.

Answers may include:
- Terminology: monopoly, oligopoly, market power.
- Diagram: Of imperfect competition to depict a firm with significant market power. Candidates may also choose to use a diagram to compare monopoly with perfect competition.
- Theory: an explanation of the various advantages and disadvantages of monopoly or oligopoly power. Candidates may use perfect competition as a basis for comparison to identify points of argument relating to market power.
- Synthesis (discuss): A discussion is likely to identify arguments in favour of market power such as economies of scale and the case of a natural monopoly, ability to invest abnormal profits in research, leading to new technologies and improved product quality, etc. Arguments against monopoly such as abuse of pricing power, reduced output and allocative inefficiency. State owned firms versus non state-owned firms.
- Example(s): of firms that have monopoly power, these could be oligopoly or monopoly firms.

Assessment Criteria

Marks

Level descriptor

0

- The work does not reach a standard described by the descriptors below.

1-3

- The response indicates little understanding of the specific demands of the question.

- Economic theory is stated but it is not relevant.

- Economic terms are stated but they are not relevant.

- The response contains no evidence of synthesis or evaluation.

- A real-world example(s) is identified but it is irrelevant.

4-6

- The response indicates some understanding of the specific demands of the question.

- Relevant economic theory is described.

- Some relevant economic terms are included.

- The response contains evidence of superficial synthesis or evaluation.

- A relevant real-world example(s) is identified.

7-9

- The response indicates understanding of the specific demands of the question, but these demands are only partially addressed.

- Relevant economic theory is partly explained.

- Some relevant economic terms are used appropriately.

- Where appropriate, relevant diagram(s) are included.

- The response contains evidence of appropriate synthesis or evaluation but lacks balance.

- A relevant real-world example(s) is identified and partly developed in the context of the question.

10-12

- The specific demands of the question are understood and addressed.

- Relevant economic theory is explained.

- Relevant economic terms are used mostly appropriately.

- Where appropriate, relevant diagram(s) are included and explained.

- The response contains evidence of appropriate synthesis or evaluation that is mostly balanced.

- A relevant real-world example(s) is identified and developed in the context of the question.

13-15

- The specific demands of the question are understood and addressed.

- Relevant economic theory is fully explained.

- Relevant economic terms are used appropriately throughout the response.

- Where appropriate, relevant diagram(s) are included and fully explained.

- The response contains evidence of effective and balanced synthesis or evaluation.

- A relevant real-world example(s) is identified and fully developed to support the argument.

[Maximum number: 10]

1. Capsicum prices reach NZ $\$ 24$ per kilogram
The price of capsicums, a common vegetable in New Zealand, reached an all-time high of NZ$24 per kilogram (kg) in 2021. Vegetable prices in New Zealand rose 15% in 2021, driven by higher prices for cucumbers, lettuce, capsicums and broccoli.
A consumer prices analyst said "prices for many vegetables typically rise in winter. However, we are seeing larger rises than usual for this time of the year and for a greater number of vegetables." It has been suggested that price increases are larger than usual because of the market power of the supermarkets in New Zealand.
Figure 1 illustrates a decrease in supply in the market for capsicums in New Zealand.

Figure 1

High profits: New Zealand considers breaking up supermarket duopoly¹
New Zealand's supermarket industry is dominated by two huge firms, Foodstuffs and Woolworths. Together, their stores control about 85 % of the total market, giving them significant market power.
A report by the New Zealand Commerce Commission has found that these supermarkets are making huge profits and charging some of the highest prices in the OECD².
A government official said the government would "do whatever it takes to make sure New Zealanders get a fair deal at the checkout".
The major retailers appear to avoid competing strongly with each other, particularly on price. Meanwhile, competitors wanting to enter the market or expand face significant barriers to entry, including a lack of suitable sites for large scale stores.
The government has strict regulations limiting the sites that can be used for building supermarkets. The big supermarkets have been buying the limited sites in order to prevent competitors from entering the market.
It has been reported that the entry of a German retailer into the Australian supermarket industry, which was also dominated by two firms, has increased competition, cut prices by around 13 % and saved customers more than NZ $\$ 2$ billion per year.
${ }^{1}$ duopoly: a market dominated by two firms
${ }^{2}$ OECD: The Organisation for Economic Co-operation and Development

Using the text/data provided and your knowledge of economics, recommend a policy which could be introduced by the New Zealand Commerce Commission to limit the possible abuse of market power in the supermarket industry in New Zealand.

Possible policies may include (but are not restricted to):
- Legislation to force supermarkets to sell part of their business/their land
- Removing barriers to the entry of new competitors
- Sponsoring or facilitating a new competitor
- Price regulation
- Government ownership/nationalization
- Government policy to release more land for building shops/retail activities (deregulation)
- Fines that arise from fair-trading laws (anti-trust legislation)
- Windfall tax on super normal profits
- Any other valid policy.

Marks	Level descriptor
0	- The work does not reach a standard described by the descriptors below.
1-2	- The response identifies a policy. - The response uses no economic theory to support the recommendation. - Economic terms are stated but are not relevant. - The response contains no use of text/data to support the recommendation. - The response contains no evidence of synthesis or evaluation.
3-4	- The response identifies an appropriate policy. - The response uses limited economic theory to support the recommendation in a superficial manner. - Some relevant economic terms are included. - The response contains no use of relevant text/data to support the recommendation. - The response contains evidence of superficial synthesis or evaluation.
5-6	- The response identifies and explains an appropriate policy. - The response uses relevant economic theory to partially support the recommendation. - Some relevant economic terms are used appropriately. - The response includes some relevant information from the text/data to support the recommendation. - The response contains evidence of appropriate synthesis or evaluation but lacks balance.
7-8	- The response identifies and fully explains an appropriate policy. - The response uses relevant economic theory to support the recommendation. - Relevant economic terms are used mostly appropriately. - The use of information from the text/data is generally appropriate, relevant and applied correctly to support the recommendation. - The response contains evidence of appropriate synthesis or evaluation that is mostly balanced.
9-10	- The response identifies and fully explains an appropriate policy. - The response uses relevant economic theory effectively to support the recommendation. - Relevant economic terms are used appropriately throughout the response. - The use of information from the text/data is appropriate, relevant and supports the analysis/evaluation effectively. - The response contains evidence of effective and balanced synthesis or evaluation.

IB Economics HL 2.11 Market Failure Market Power Topic Practice

Covered syllabus points

IB Economics HL 2.11 Market Failure Market Power Topic Practice

Covered syllabus points

Question 1

Question (a)

Question (b)

Question 2

Question (a)

Question (b)

Question (c)

Question (d)

Question (e)

Question 3

Question (a)

Question (b)

Question 4

Question 5

Question 6

Question 7

Question 8

Question 9

Question 10