2.11: Market Power

What is a market structure?

Characteristics of a market organisation that determines behaviour of firms.

What is the fundamental distinction between different market structures?

Market power.

What is market power?

Ability of each firm in the industry to control the price of the product they are selling.

What are the four market structures?

- Perfect competition.

- Monopolistic competition.

- Oligopoly.

- Monopoly.

Which market structure leads to allocative efficiency?

Perfect competition.

Which market structures lead to market failure? (3)

- Monopolistic competition.

- Oligopoly.

- Monopoly.

Which market structures lead to allocative inefficiency? (3)

- Monopolistic competition.

- Oligopoly.

- Monopoly.

Which market structure lead to the greatest degree if market failure?

Monopoly.

What features define each market structure? (4)

- Market power.

- Relative number of firms in the industry.

- Level of product differentiation.

- Barriers to entry.

What are revenues?

Payments received by firms when they sell products.

What is total revenue?

Total earnings of a firm.

How to calculate total revenue?

Price x Quantity Sold.

What is marginal revenue?

Additional revenue from selling an additional unit of output.

How to calculate marginal revenue?

Change in total revenue / Change in quantity sold.

What is average revenue?

Revenue per unit sold.

How to calculate average revenue?

Total Revenue / Quantity Sold.

Average revenue is equal to...

Price.

What happens to price when output changes in perfect competition?

Price is constant in perfect competition.

What happens to price when output changes in monopolistic, oligopoly or monopoly?

Price may vary with output.

What are costs of production?

Payments made by firms to buy resources (factors of production).

What is total cost?

All costs of production incurred by a firm.

What is marginal cost?

Additional cost of producing an additional unit of output.

How to calculate marginal cost?

Change in total cost / Change in quantity.

What is average cost?

Cost per unit of output.

How to calculate average cost?

Total cost / quantity.

What are explicit costs?

Payments made to acquire resources from outsides.

What are implicit costs?

Sacrificed income by using self-owned resources.

What are economic costs?

Total cost of using self-owned and purchased resources.

How to calculate economic costs?

Explicit costs + Implicit costs.

What is economies of scale?

When the average production costs decrease as the firm increases output.

What leads to economies of scale? (5)

- Specialisation of labour.

- Specialisation of management.

- Bulk buying of inputs.

- Financing economies (lower interest rates for larger firms).

- Spreading costs of larger volumes of output.

What is diseconomies of scale?

When the average production costs increase as the firm increases output.

What leads to diseconomies of scale? (3)

- Coordination and monitoring difficulties.

- Communication.

- Difficulties.

What is accounting profit?

Profit made only considering explicit costs.

How to calculate accounting profit?

Total revenue - explicit costs.

What is economic profit?

Profit made when considering economic costs (both explicit and implicit costs).

How to calculate economic profit?

Total revenue - economic costs.

What is normal profit?

When total revenue = economic costs; economic profits = 0.

What is abnormal profit?

When total revenue > economic costs; positive economic profits.

What happens when economic profit = 0?

Firm is making normal profit.

What happens when economic profit > 0; positive?

Firm is making abnormal profit.

What is a loss?

When total revenue < economic costs; negative economic profits.

What happens when economic profit < 0; negative?

Firm is making a loss.

What happens when an industry offers abnormal profits to firms?

Firms have an incentive to enter the market.

What happens when an industry offers normal profits to firms?

Firms have no incentive to enter or exit.

What happens when an industry offers losses to firms?

Firms have an incentive to leave the market.

How do firms maximise profits? (2)

- Produce at level where total revenue - total cost is greatest.

- Produce at level where marginal cost = marginal revenue.

What are the characteristics of perfect competition? (3)

- Many firms.

- No barriers to entry,

- All firms sell a homogenous product.

What is the market power of firms in perfect competition?

No/little market power; price takers.

Describe the graph representing perfect competition. (3)

- D = P = MR = AR curve.

- MC curve.

- AC curve.

What happens if a firm in perfect competition raises their price?

Buyers will substitute to a lower price at another firm.

What happens if a firm in perfect competition lowers their price?

Lose revenue.

When do firms make abnormal profit in perfect competition (short-term)?

When the price at MC = MR is greater than AC.

When do firms make normal profit in perfect competition (short-term)?

When the price at MC = MR is equal to AC.

When do firms make a loss in perfect competition (short-term)?

When the price at MC = MR is less than AC.

What profits/losses do firms in perfect competition make in the short term?

- Abnormal profits.

- OR normal profits.

- OR losses.

Can firms in perfect competition make abnormal profit in the short run?

Yes.

Can firms in perfect competition make normal profit in the short run?

Yes.

Can firms in perfect competition make losses in the short run?

Yes.

What profits/losses do firms in perfect competition make in the long run?

Can only make normal profit.

Can firms in perfect competition make abnormal profit in the long run?

No.

Can firms in perfect competition make normal profit in the long run?

Yes; only make normal profit in the long run.

Can firms in perfect competition make losses in the long run?

No.

Why can firms in perfect competition only make normal profit in the long run?

- If there was abnormal profits, firms would enter, increasing supply, decreasing prices, no abnormal profits, only normal.

- If there were losses, firms would leave, decreasing supply, increasing prices, no losses, only normal profits.

Is allocative efficiency achieved in perfect competition?

Yes.

What are the benefits of perfect competition? (4)

- Allocative efficiency.

- Low prices.

- Remains competitive and efficient.

- Market responds to consumer tastes.

What are the limitations of perfect competition? (4)

- Unrealistic in the real world.

- Cannot take advantage of economies of scale.

- Lack of product variety; homogenous products.

- Difficult to engage in research and development.

What are the characteristics of monopolies? (4)

- Single firm in the industry.

- Unique product; no close substitute.

- Extreme barriers to entry.

- No competition; very high market power (price-maker).

What are the barriers to entry into a monopoly? (7)

- Economies of scale.

- Natural monopolies.

- Branding.

- IP legal barriers.

- Legal barriers.

- Control of essential resources.

- Aggressive tactics.

Describe the graph representing monopolies. (4)

- Downwards sloping demand curve (D = AR = P).

- Downwards sloping MR curve below demand curve.

- AC curve.

- MC curve.

When is total revenue maximized?

When MR = 0.

When do monopolies make abnormal profit?

When P > AC at the point where MR = MC.

When do monopolies make normal profit?

When P = AC at the point where MR = MC.

When do monopolies make losses?

When P < AC at the point where MR = MC.

Why is the distinction between short and long run not important when considering monopolies?

New firms cannot enter.

What are the conditions of the short run? (2)

- At least one input is fixed.

- Firms cannot enter or leave (cannot vary inputs).

What are the conditions of the long run? (3)

- Inputs are not fixed.

- Firms can enter or leave industry.

- Firms can change in size.

What is a natural monopoly?

Firms with economies of scale so great they can supply entire market at a lower average costs than two or more firms.

By graph, what can indicate a natural monopoly seen?

When the demand curve intersects LRAC while it is still falling.

What industries are usually natural monopolies?

Industries with high capital costs i.e. satellites, pipes, cables.

What are some examples of natural monopolies? (8)

- Water distribution.

- Gas distribution.

- Electricity distribution.

- Cable television.

- Fire protection.

- Postal services.

- Police force.

Does monopoly achieve allocative efficiency?

No.

Does monopoly lead to market failure?

Yes.

How does monopoly impact consumer surplus?

Smaller consumer surplus; high prices, low output.

How does monopoly impact producer surplus?

Larger consumer surplus; high prices.

How does monopoly welfare?

Welfare loss.

Describe resource allocation in monopoly.

Underallocation; not enough produced.

What are the criticisms of monopoly? (6)

- Welfare loss / allocative inefficiency / market failure.

- High price and low output.

- Loss of consumer surplus.

- Negative impact on income distribution.

- Lack of competition; high costs, inefficiency.

- Maybe less innovative; no incentive.

What are the potential benefits of monopoly? (3)

- Economies of scale; low prices and increased output.

- Natural monopoly; low prices and increased output.

- Research and development; innovation.

What are the characteristics of monopolistic competition? (3)

- Large number of firms.

- No barriers.

- Product differentiation.

What are some examples of product differentiation in monopolistic competition? (5)

- Physical differences (size, shape, materials, texture, taste etc).

- Quality differences.

- Location.

- Services (make product attractive i.e delivery, warranty).

- Product image.

Why is it called monopolistic competition?

Each firm is a mini-monopoly for their own goods; substitutes available.

Describe the graph representing monopolistic competition. (4)

- Downwards-sloping demand curve (D = AR = P).

- MR curve below demand curve.

- MC curve.

- AC curve.

What is price competition?

When firms lower price to attract consumers away from rivals.

What is non-price competition?

When firms use methods other than price to attract consumers from rivals.

What are some examples of non-price competition? (3)

- Product differentiation.

- Advertising.

- Branding.

How elastic is the demand curve in monopolistic competition?

Relatively elastic.

How can firms in monopolistic competition reduce elasticity of demand curve? (2)

- More differentiation.

- Prove superiority.

How can firms in monopolistic competition increase market power? (2)

- More differentiation.

- Prove superiority.

Can firms in monopolistic competition make abnormal profit in the short run?

Yes.