Market Power Overview

Market Structures, Profit Maximisation, Perfect Competition

What are market structures?

The characteristics of a market affecting firm behaviour and outcomes

What are features of market structures?

• Number of buyers/sellers

• Size of firms

• Type of product → homogenous/differentiated

• Barriers to entry and exit

• Degree of competition

What are the types of market structures?

• Perfect competition

• Imperfect competition

  • Monopolistic competition

  • Oligopoly

  • Monopoly

What is perfect competition?

• Many firms

• No market power

• Homogenous goods

What is monopolistic competition?

• Many firms

• Slight market power due to product differentiation

What is a oligopoly?

• Few large firms dominate

• High interdependence

What is a monopoly?

• Single firm dominates

• Significant market power

What is market power?

A firm’s ability to influence price and output

How does market power lead to market failure?

• Price manipulation

• Output restriction

• Lack of allocative/productive efficiency

How is market power measured by?

• Market share

• Concentration ratios

• Barriers to entry

• High market power → less competition, potential inefficiency

• Lower market power → more competition, efficient outcomes

What are the key characteristics of perfect competition?

• Many buyers and sellers → price takers

• No barriers to entry/exit → easy market access

• Perfect knowledge → full information on prices

• Homogenous products → no brant loyalty

• Firms cannot influence price → P = AR = MR = Demand

• Allocative efficiency

• Productive efficiency

• Dynamic efficiency is unlikely due to lack of abnormal profits

What is allocative efficency?

AR = MC

What is productive efficiency?

MC = AC

What are characteristics of an imperfect competition diagram?

• Firm is a price maker → downward sloping demand and revenue curves

• Produces at MC = MR (profit maximisation)

• Not productively efficient: AC > MC

• Not allocatively efficient: AR > MC

• Likely dynamically efficient due to reinvested profits and innovation

What are explicit costs?

Direct payments (eg. wages, raw materials)

What are implicit costs?

Opportunity costs (eg. forgone interest from investment)

• Entrepreneurs consider implicit costs when deciding whether to reallocate resources

What are total costs (TC)?

Explicit + implicit costs

What is profit?

Total revenue (TR) - Total costs (TC)

What is normal profit?

TR = TC → breakeven

What is abnormal profits?

TR > TC

What is losses?

TR < TC

What is the profit maximisation rule?

Firms aim to maximise profit to benefit stakeholders via dividends or rising share prices

What are dividends?

Distribution of earnings from a company to its stakeholders

When is profit maximised?

• MC = MR → no extra profit from producing another unit

• MC < MR → produce more, profit increases

When is profit not maximised?

• MC > MR → firms stop producing, loss on extra units

Why may firms not always know where MC = MR?

• Frequent cost changes (short term)

• Consumer disruption from regular price shifts (short term)

• Regulatory constraints (long term)

What is the formula for average cost (AC)?

Total costs / output

What is the formula for average revenue?

Total revenue / output

How do you calculate per unit profit?

Average revenue - average costs

How does profit maximisation work in perfect competition?

• Firms produce where MC = MR

• Short run, firms can make

  • Abnormal profit: AR > AC

  • Losses: AR < AC

• Long run, firms always make normal profits due to:

  • No barriers to entry/exit

  • New firms enter if profits exist → shifts supply right → price falls

  • Firms exit if losses occur → shifts supply left → price rises

What are some diagram notes for perfect competition?

• Short run abnormal profit: AR > AC at MC = MR

• Short run losses: AR < AC at MC = MR

• Long run equilibrium: AR = AC - P, normal profit only

• Supply shifts adjust market price until normal profit is restored

What is the link between efficiency in perfect competition?

• Allocative efficiency: P = AR = MC → resources maximally allocated

• Productive efficiency: MC = AC → lowest average cost, no resource waste

• Long run: perfect competition achieves both efficiencies

What is the profit maximisation point?

MC = MR