Market Power as a Form of Market Failure Concepts (HL ONLY)

Assumptions and characteristics oligopoly

A Few Large Firms Irrespective of the number of firms in the industry, an oligopolistic market is dominated by a few large firms. For example, there may be hundreds of small. independent supermarkets operating under a variety of names in a country, but these are likely dominated by a few large firms. Dominance is measured by using concentration ratios. High Barriers to Entry The BLADE acronym applies here. These barriers also prevent prices from falling in oligopolistic markets. Interdependence Firms in oligopoly are interdependent. In a market consisting of a few large firms, it is possible for an oligopolist to clearly identify its competitors. Hence, the actions of one dominant firm will impact the rest of the firms in the industry. Interdependence causes price rigidity in non-collusive oligopolistic markets as there is no direct gains for a firm in reducing its prices. Owing to the nature of interdependency and rigidity in oligopolistic markets, firms have to look for other ways to compete with each other, known as non-price competition.

Profit maximisation in both the short run and the long run

Abnormal Profit/Supernormal Profit/Economic Profit Abnormal profit is profit in excess of the amount needed to generate a return on the firm's capital investment. It creates incentives for existing firms to produce and for potential rivals to enter the market. Abnormal profit occurs when AR>AC. A firm earns abnormal profit from economic activity only when it experiences a profit greater than from its next best alternative. Perfect Competition - Firms can earn abnormal profits in the short run. Monopoly - Monopolies can earn abnormal profits in both the short and long run. Oligopoly - Same as monopoly, whether non-collusive or collusive Monopolistic Competition - Firms can earn economic profit in the short run. Normal Profit Unlike accountants, economists regard normal profit as a cost of production because without this, there is no incentive for the good or service to be provided. The condition for normal profit is AR=AC. If firms only earn normal profit, then it will only cover production costs from its total revenue. Hence, normal profit is sufficient to keep the firm in business. Perfect Competition - Firms can only earn normal profits in the long run. The long run condition MR=MC=AR=AC must hold in perfectly competitive markets. Monopoly - Firms might only earn normal profits in the short run, possibly due to the monopolist reducing the price as a deliberate deterrent to potential entrant to the market. Oligopoly - Same as monopoly, whether non-collusive or collusive. Monopolistic Competition - Firms can only earn normal profit in the long run due to absence of barriers to entry, which allows more firms to enter the contestable market, attracted by the prospect of earning abnormal profit, reducing the market price until AR=P=AC and reverting all firms to a position of normal profit. Same applies for loss-making position, but firms exit rather than enter the industry, causing the market price to increase to AR=P=AC, reverting firms back to normal profit position. Loss/Negative Economic Profit Production costs exceed its total revenue, that is, TC>TR. This is because the firm's price is not sufficient to cover its unit costs of production. Hence, losses occur when AR<AC.While it is possible for a loss-m

Summary of Market Structures

Here is a table that sorts and summarises the market structures and their characteristics.

Assumptions and characteristics of perfect competition

Many Firms Perfect competition assumes there are a very large number of buyers and sellers in the industry. Firms in perfect competition are price takers. This means no individual firm is large enough to have the market power to influence the equilibrium output or price. The existence of many firms in the industry, none of which are large enough to have market power, also implies there is perfect information. Barriers Barriers to entry are non-existent in perfect competitive markets, so there is freedom of entry into and exit from such industries. One factor that keeps prices in perfect competition at a perfectly competitive level is the fact that other firms can join the industry and take profits from firms currently operating in the market. This means that if a firm increases its price, this may signal to other firms that they can operate more profitably by entering that market. Likewise, the ability for a firm to exit a market freely is also important in maintaining a perfectly competitive price. If there are only a small number of consumers in an industry, with market power, then they may manipulate price below a perfectly competitive level. Homogeneous Products They supply products that are identical rather than differentiated. If firms sell homogeneous goods or services, then the competition between them becomes more intense. Homogeneous goods should, in theory, not only relate to the good but also the consumption experience of the good.

Assumptions and characteristics of monopolistic competition

Many Firms There are many firms in monopolistically competitive market, just like perfect competition. However, they do not produce or sell homogeneous products, meaning that each firm has a small degree of market power, allowing firms are able to determine prices to a small extent. Free Entry The monopolistic competition model assumes that there is no barriers to entry and exit from the industry. Any firm is free to set up in the market and compete with the existing firms. Product Differentiation Firms in monopolistic competition have the ability to differentiate their goods and services, which is mainly what accounts for the differences in prices. However, they are essentially competing for the same customers in the local area.

Firm as a 'price taker' vs. firm as a 'price maker'

Perfect competition firms are price takers as firms do not have market power. The rest of the market structures in the syllabus are price makers as there are varying but existing degrees of market power.

Assumptions and characteristics of monopoly

A Single or Dominant Firm A pure monopoly exists when there is only one firm in the market. Some economists argue that a monopoly is a dominant firm with significant power in a market. High Barriers to Entry The entry barriers can be remembered by the acronym BLADE: Branding - a monopoly has such a large amount of brand awareness that if a new firm was to enter the industry, it would be very challenging and expensive for it to advertise enough to compete with the incumbent's brand. Legal barriers - There can sometimes be legal reasons why firms cannot enter a market such as licences or health and safety requirements. Monopolists can also create artificial barriers to entry by protecting their intellectual property rights through the use of copyrights, trademarks, and patents. Anti-competitive practices - some monopolies may take measures or engage in practices that prevent other firms from entering their market. For example, the use of limit pricing strategy means a monopolist deliberately sets the price of their good or service below the price at which it would be possible for a new entrant to sell it. Domination of resources - all resources that are required could currently be used by the monopolist, making it difficult or impossible for a new firm to enter the market. Economies of scale - these are the cost-saving benefits of lower average costs of production brought about by an increase in the volume of production. There may not be enough demand in the market for a new firm to achieve the necessary economies of scale to compete. No Close Substitutes Monopolists can enjoy its market position as firms can supply a unique good or service and charge higher prices and control market supply. Monopolists enjoy price inelastic demand for their product.