4.2.1 Market failure

Question 1

what is market failure concerning competition

Answer 1

• Inefficient allocation of resources → wastage means that consumers can be better off than they are currently
• Competition is present to drive down costs and provide consumer choice and higher quality
• Efficient markets: consumers have power and markets respond
• When producers gain monopoly power in a market, market failure starts to occur

Question 2

when is market failure observed

Answer 2

• prices are higher than they need to be and firms are earning abnormal profits
• Output may be restricted and consumer loses out
• Choice may be reduced and innovation slowed

Question 3

why is market power significant for a firm

Answer 3

• Firm gains control over the market
• Spends less time and effort competing as less competition in the market
• They can exert some control over the market → prices, output, barriers to entry, other producer actions and monospony power

Question 4

cartels

Answer 4

• Agreement within a group of businesses to reduce competition, avoiding competing with eachother, secret
• Anti competitive → increase prices and not actively compete with eachother
• Directly affect the purchasers of their products → illegal
• Reduce incentive for a business to operate efficiently and innovate so damage economy
• Likely to be in economies where competition is limited already eg oligopoly

Question 5

what may cartels do

Answer 5

• Fix prices at a higher level than market Equ, or firms may agree to not try to compete on price competition
• Output levels can fixed to restrict supply and increase prices
• Market sharing so each member of cartel has own area, where others do not try to compete
• Preferential supply restricts number of customers and outlets they supply - makes product more exclusive and forces up the prices
• Bid rigging - cartel members may pretend to compete to win contracts but take in turns to have the lowest bid → charge higher prices for a contract than if they were actually competing

Question 6

what is collusion

Answer 6

• Explicit collusion: involved two or more firms discussing plans and agreeing to follow a joint strategy
• Tacit agreement: competing firms may not communicate in a way → prices stable at same levels, prices usually higher than market price and avoid cutting them

Question 7

restrictive practices

Answer 7

• Any action that a business might use to limit competition
• Cartels, collusions and preferential supply
• Governments and regulation to stop firms entering a market can become restrictive

Question 8

examples of restrictive practices

Answer 8

• Forcing retailers to not stock a competitors products
• Refusing to supply retailers who discount products
• Tie in sales: suppliers forced to stock a full range of supplier goods rather than the best selling ones
• Resale price maintenance: suppliers force retailers to not discount prices

Question 9

monopsony power

Answer 9

• Buyer has power over sellers
• Buyer can drive down cost of inputs and thus lowering the cost of production
• May sound good initially as low costs = low prices
• Suppliers will be impacted as they struggle to pay very low wages to workers
• Monoposny power → monopoly power if monopsony leads to increased CA and consumers have less choice
• Eg small book sellers and amazon
• Tesco demanding price cuts from suppliers to become more price competitive with Aldi → 2020

Question 10

natural monopoly

Answer 10

• Considered to be most efficient form of market structure → water, rail etc
• Due to high fixed costs of capital of these services → waste to have more than one
• A natural monopoly is just as likely to use monopoly power against public interest → no competition creates no incentive to compete on price
• No competition → no pressure to be efficient → rising costs and quality of service decreased
• Investment decreases and innovation not priority

Question 11

power in labour market

Answer 11

• Both monopsony and monopoly in labour market
• Trade union/professional body can restrict supply of labour to particular industry or profession
• Can negotiate working conditions or force pay above free market levels, higher cost labour passed onto consumer with higher prices
• Monopsony employers can pay below free market wages as employees have no one else to work for eg NHS and public sector
• Bilateral monopolies can become a problem for government → monopoly and monospony
• Rolls royce cras gooodwood factory receive pay award → workers get up to 17.6% after negotiations between firm and Unite the union; more thna inflation of 10.7% → 2022

Question 12

implications of market failure for consumers

Answer 12

• Restriction on competition and increase in prices
• If the consumer faced increased prices their disposable income is reduced
• Standard of living is reduced
• Consumer choice decreased, products lack differentiation and innovation to satisfy choice

Question 13

implications of market failure for businesses

Answer 13

• Firms can gain EOS and charge lower prices for consumers
• Restrictive practices increase their profit but reduce consumer choice and raise prices
• If there is not strong domestic competition, their efficiency decreases
• Weakens competition in foreign markets, as exports will be reduced and imports high as foreign firms seen as having higher innovation/cheaper, increased CA
• Restrictive practices increase profits and achieve a degree of monopoly power in the market
• Competitive domestic markets lead to a high level of innovation; profitable and lead to success in export markets

Question 14

implications of market failure for governments

Answer 14

• Public interest is key issue
• Achieve economic growth and market failure slows that → international competition reduced
• Growth needs a market to be competitive and innovate
• Need to regulate market power to reduce failure in markets
• Gov deals with suppliers with power to overcharge → eg for defense