HL IB Economics 2.11 Market Failure: Market Power

Flashcards on Market Failure: Market Power, covering market structures, profit maximization, competition, monopolies, oligopolies, monopolistic competition, and government intervention.

Market Structures

The characteristics of the market in which a firm or industry operates, including the number of buyers, the number and size of firms, the type of product, barriers to entry and exit, and the degree of competition.

Monopolistic Competition

A market structure with many firms offering similar but differentiated products.

Oligopoly

A market structure dominated by a few large firms with significant market power.

Monopoly

A market structure with a single supplier who can influence market supply and price.

Market Power

The ability of a firm to influence and control market conditions, impacting price, output, and other market variables.

Signs of Market Failure due to Market Power

Control of prices and restriction of output by suppliers, leading to inefficiency.

Antitrust Laws/Competition Policy

Laws and policies used by governments to regulate markets and prevent the abuse of market power.

Market Competition

In competitive markets, no single firm has substantial market power, and prices and outputs are determined by supply and demand.

Characteristics of Perfect Competition

Many buyers and sellers, no barriers to entry or exit, perfect knowledge of prices, and homogenous products.

Firm Behavior in Perfect Competition

Firms cannot influence the price and quantity; selling price equals market price (P = MR = AR = Demand).

Market Structures Under Imperfect Competition

Monopolistic, Oligopoly, and Monopoly.

Key Characteristics of Monopoly

Differentiated; high customer loyalty; price maker; high barriers to entry; abnormal profits.

Explicit Costs

Costs which have to be paid e.g. raw materials, wages etc.

Implicit Costs

The opportunity costs of production.

Normal Profit

Total Revenue = Total Cost (TR = TC).

Abnormal Profit

Total Revenue > Total Cost (TR > TC).

Profit Maximization Rule

Marginal Cost (MC) = Marginal Revenue (MR).

Issues of the Profit Maximisation Rule

Firms following the profit maximisation rule sometimes incur high prices for consumers.

Market Power in Perfect Competition

Low market power, low market share, and low industry concentration ratio.

Perfect Competition in the Short-Run and Long-Run

Firms can make abnormal profit or losses in the short-run in perfect competition; however, they will always return to the long-run equilibrium where they make normal profit.

Shift of the Supply Curve

Due to the increase in supply, the industry price falls.

Allocative Efficiency

Occurs at the level of output where Average Revenue = Marginal Cost (AR = MC).

Productive Efficiency

Occurs where Marginal Cost = Average Cost (MC = AC).

Market Power in a Monopoly

High/absolute level of market power, high/total market share, and high/perfect industry concentration ratio.

Monopoly Market

A market structure in which there is a single seller, no substitute products, and complete market power.

Higher Profits

Prices are often set above marginal costs, allowing firms to earn abnormal profits.

Economies of Scale

Larger firms can take advantage of economies of scale to lower their average costs, or lower prices to consumers.

Natural Monopolies

These markets spend large sums in production, but demand will decrease if another firm enters the market.

Oligopoly Market Structures

Banks, insurance companies, department stores, supermarkets, petrol retailers, sport stores etc.

Market Power in Oligopoly

The level of market power is high for oligopoly firms, large market share, and high concentration ratio.

High Barriers to Entry & Exit in Oligopoly

Entering the industry is difficult due to the existing dominance of relatively few firms.

Concentration Ratio

Reveals what percentage of the total market share a specific number of firms have

Interdependence of Firms

Firms study each other's behavior and are highly interdependent in their actions.

Product Differentiation

Products tend to be highly differentiated.

Collusive Behaviour in Oligopolies

When firms cooperate to fix prices and restrict output

Five-Firm Market Share

Five firms with a concentration ratio of 80% meet secretly and agree to fix prices at a particular level.

Overt Collusion

Occurs when firms explicitly agree to limit competition or raise prices (price fixing).

Tacit Collusion

Occurs when firms avoid formal agreements but closely monitor each other's behaviour usually following the lead of the largest firm in the industry

Game Theory

Ensures optimal decisions are made in a strategic setting where there is a high level of interdependence.

Price Wars:

When competitors repeatedly lower prices to undercut each other in an attempt to gain or increase market share; firms find it difficult to collude

Predatory Pricing:

practice of lowering prices when a new competitor joins the industry in order to drive them out.

Limit Pricing:

occurs when firms set a limit on how high the price will go in the industry (the greater the barriers to entry, the higher the limit price is likely to be).

Types of Non-price Competition

Aims to increase product differentiation, develop or increase brand loyalty, & to increase market share.

Monopolistic Competition

Nail salons, hairdressing or barber shops, massage parlours, fruit and veg stores.

Number of Firms in Monopolistic Competition

There are a large number of small firms & each one is relatively small and can act independently of the market.

Comparison of Graph - Monopoly vs Monopolistic

The diagrams are essentially the same, howeverthe monopoly revenue curves are steeper (more inelastic)

Legislation & Regulation

prevent anti-competitive practices and protect consumers, workers and the environment.

Role of Government

To prevent (or limit) a monopoly from forming.

Protecting Employees' Wage

Wage bills for firms are often one of their highest costs as a proportion of expenditure (firms will seek to reduce); this is a goal of profit maximisation.

Nationalisation

Takes control and ownership of firms which were in the private sector.

Reducing Power Through Fines

are usually imposed by regulators in specific markets (firms are fined 10% of their sales revenue for breaching anti-competitive practices).