Unit 2.11 - Market Failure: Market Power [HL only]
What you need to know and understand:
Key concepts:
Concepts to understand:
- Perfect competition–many firms, free entry, homogeneous products
- Monopoly—single or dominant firm, high barriers to entry, no close substitutes
- Imperfect competition
- Oligopoly—few large firms, high barriers to entry, interdependence
- Monopolistic competition—many firms, free entry, product differentiation
- Rational producer behaviour—profit maximization (HL only)
- Total revenue - Total costs (TR -TC)
- Marginal cost = Marginal revenue (MC=MR)
- Abnormal profit (AR > AC)*
- Normal profit (AR = AC)*
- Losses (AR < AC)*
- AR = Average revenue, AC = Average cost
- Degrees of market power
- Meaning of market power
- Perfect competition—no market power—firm as price taker
- profit maximization:
- in the short run
- in the long run
- Meaning of allocative efficiency, necessary conditions
- Imperfect competition—varying degrees of market power—firm as price maker
- Monopoly
- Profit maximization
- Allocative inefficiency (market failure)
- Welfare loss in a monopoly in comparison with perfect competition due to restricted output and higher price
- Natural monopoly
- Oligopoly
- Collusive versus non-collusive
- Interdependence, risk of price war, incentive to collude, incentive to cheat
- Allocative inefficiency (market failure) simple game theory payoff matrix
- Price and non-price competition
- Measurement of market concentration – concentration ratios
- Monopolistic competition
- Profit maximization:
- in the short run
- in the long run
- Less market power due to many substitutes—more elastic demand curve compared with monopoly
- Allocative inefficiency (market failure)
- Less inefficiency, more product variety
- Profit maximization:
- Advantages of large firms having significant market power, including:
- Economies of scale including natural monopolies
- Abnormal profits may finance investments in research and development (R&D), hence innovation
- Risks in markets dominated by one or a few very large firms
- Risks in terms of output, price, consumer choice
- Government intervention in response to abuse of significant market power
- Legislation and regulation
- Government ownership
- Fines
Key concepts:
- Scarcity
- Choice
- Efficiency
- Equity
- Economic well-being
- Sustainability
- Change
- Interdependence
- Intervention
Concepts to understand:
- The market mechanism may result in socially undesirable outcomes that do not achieve efficiency, environmental sustainability and/or equity.
- Market failure, resulting in allocative inefficiency and welfare loss.
- Resource overuse, resulting in challenges to environmental sustainability.
- Inequity, resulting in inequalities.
- Governments have policy tools which can affect market outcomes, and government intervention is effective, to varying degrees, in different real-world markets.
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