HL Market power

Question 1

Market power definition

Answer 1

The extent to which a firm can control the price of the product sold

Question 2

Price takers

Answer 2

Firms cannot raise the price because demand falls to zero (perfect competition)

Question 3

Price setters

Answer 3

In imperfect competition firms have some degree of market power

Question 4

Market structure

Answer 4

Categorising a firm in a particular industry based on their level of market power

Question 5

Factors that determine market power (3)

Answer 5

1. Number and size of competing firms 2. Nature of barriers of entry 3. Degree and intensity of competition (price and non-price)

Question 6

Perfect competition assumptions (5)

Answer 6

1. Large number of small firms 2. goods are homogeneous 3. No barriers of entry/exit 4. Firms will be SR profit maximisers 5. Perfect knowledge amongst firms/consumers

Question 7

Perfect competition graph

Answer 7

Industry -> S = (MR=D=AR), Firm -> Perfectly elastic demand

Question 8

Three profit options for short run (Perfect competition)

Answer 8

1. Normal profits (P=AC), 2. Abnormal profits (P>AC), 3. Losses (P<AC)

Question 9

How long run equilibrium is achieved in PCM

Answer 9

Abnormal profits are a signal for others to enter to the market -> supply will increase, demand for og firm decrease -> price falls -> normal profits, less production

Question 10

Productive efficiency

Answer 10

MC=AC (producing at lowest possible unit cost)

Question 11

Profitmax

Answer 11

MC=MR

Question 12

Allocative efficiency

Answer 12

MC=AR (supply equals demand, socially optimum level of output since everything is sold)

Question 13

Revenue maximisation

Answer 13

MR=0

Question 14

Productive and allocative efficiency in the PCM

Answer 14

Cannot be PE in SR, but in the LR can be both PE and AE

Question 15

Assumptions of monopolistic competition (5)

Answer 15

1. Fairly large number of indie small firms, 2. Some ability to set own prices, 3. No barriers of entry/exit, 4. Differentiated products, 5. Often local goods and service providers

Question 16

Curve for monopolistic competition firm

Answer 16

Downward demand curve, producing at MC=MR, pricemakers with little degree of power

Question 17

Possible SR profit/loss situations for monopolistic competition firm

Answer 17

If others haven’t entered the market, abnormal profit. When there are substitutes, og firm starts to lose market share –> demand decrease, increase in PED, price lowered and losses are made

Question 18

LR equilibrium of the firm in monopolistic competition

Answer 18

In the LR others will make losses and leave –> og firm sees increase in demand and lower PED –> firm will produce where AC is tangential to AR (normal profit only)

Question 19

Productive and allocative efficiency in monopolistic competition

Answer 19

Profit maximisers, not efficient in the SR or LR

Question 20

Monopolistic competition compared to PCM

Answer 20

higher prices, lower output, not AE due to more choices for consumers, not PE

Question 21

Monopoly

Answer 21

Market structure where only one firm dominates the market

Question 22

Assumptions of the monopoly model (3)

Answer 22

1. Single firm dominates the market – no close substitutes. 2. Barriers of entry exist (e.g. price of resources). 3. Monopolist firms may be able to make profits in the LR

Question 23

Sources of monopoly power / barriers of entry (6)

Answer 23

1. economies of scale (bigger size, smaller costs), 2. Natural monopoly (only enough resources to support one), 3. Legal barriers (patents etc,), 4. Brand loyalty, 5. Anti-competitive behaviour (e.g. gigantti), 6. Technical barriers (e.g. special techniques)

Question 24

Natural monopoly graph

Answer 24

Two demand curves: higher if normal, lower if another firm enters. LRAC cuts upper demand twice – between those points the firm makes abnormal profit because AC<AR

Question 25

Demand curve for monopoly

Answer 25

Downward sloping D, MC=MR, can choose price or level of output, price can be set between MC and D, can’t make losses in LR

Question 26

How efficient is monopoly

Answer 26

Monopolist produces at MC=MR, so not AE or PE

Question 27

Assumptions of oligopoly (5)

Answer 27

1. Relatively few large firms (when CR4 is over 40%), 2. Products are homogeneous and differentiated, 3. Barriers of entry (benefits of scale -> mergers), 4. Firms are interdependent (collusions), 5. Price rigidity

Question 28

HH index

Answer 28

Market concentration (like CR4) + competitiveness

Question 29

Collusive oligopoly, formal collusion, tacit collusion

Answer 29

Firms come to an agreement to reduce competition (setting price, dividing into regions etc.). Formal collusion (cartel): firms agree on price etc. –> illegal. Tacit collusion: same price without formal collusion.

Question 30

Non-collusive oligopoly

Answer 30

Firms compete in a normal way, strategic behaviour, game theory: optimum strategy in light of possible decisions of rival firms

Question 31

How do firms compete in oligopoly?

Answer 31

Non-price competition: brand names, packaging, advertising, sponsorships, sales promotions etc.

Question 32

Problems of monopoly and oligopoly

Answer 32

restriction of output and higher prices, lower consumer choice, P&A inefficiency, abnormal profits and inequality

Question 33

Government solutions to restricting monopoly and oligopoly

Answer 33

Legislation (mergers, takeovers, collusion), regulatory bodies of supervision (price controls, fines for Anti-C behaviour, unbundling, setting quality standards, taxes)