2.11 Market Failure: Market Power

• Marginal Costs: The increase in total cost when producing one more unit of output (q). The marginal cost isequal to the slope of the total cost curve. MC = TC/q
• • Monopolistic - A market structure is one in which there are many firms offering a similar product but with some product differentiation e.g nail salons
• Market power refers to the ability of a firm to influence and control the conditions in a specific market, allowing them to have a significant impact on price, output, and other market variables. Market power allows a firm to set prices above the competitive level or restrict output. Market power can be measured using indicators like market share, concentration ratios, or barriers to entry
• Perfect competition: A market structure in which individual firms have no market power due to the amount of competition & are unable to influence the price
• Traits of Perfect Competition: There are many buyers and sellers: due to the number of market participants, sellers are price takers.
• There are no barriers to entry and exit from the industry: firms can start-up or leave the industry with relative ease, which increases the level of competition.
• Buyers and sellers possess perfect knowledge of prices: this assumption presupposes perfect information, for example, if one seller lowers their price, all buyers will know about it.
• The products are homogenous: this means firms are unable to build brand loyalty as perfect substitutes exist and any price changes will result in losing customers.
• Price Maker: A firm with market power that is able to manipulate prices in order to change demand (Monopolistic, oligopoly, monopoly)
• Price Taker: Firms that have no market power and are unable to influence price - they take the going price offered by the market
• Monopolistic competition involves some startup costs and skills, while oligopolies may involve strategic barriers like control over essential resources.
• Oligopoly: A market structure in which a few large firms dominate the industry with each firm having significant market power
• In monopolistic competition, customer loyalty is low, and in oligopoly and monopoly, customer loyalty is high.
• Monopolistic competition has low market power linked to consumer preferences. Oligopoly and monopoly have high market power, with monopoly having absolute market power.
• Monopoly: A market structure in which there is a single supplier of a particular product & has the power to influence the market supply & price
• Market power refers to a firm's ability to influence the market price. At the profit maximisation level of output, a firm with market power sets the selling price (P1) and earns supernormal profit.
• When marginal cost (MC) is greater than marginal revenue (MR), the firm has gone beyond the profit maximisation level of output and is making a marginal loss on each unit produced.
• Firms may find it difficult to produce at the profit maximisation level of output because they may not know where this level is. In the short term, they may not adjust their prices if the marginal cost changes, and in the long term, they may be forced to change prices by the government competition regulator.
• In the long term, firms will seek to adjust prices to the profit maximisation level of output to maximize their profits.
• When marginal cost (MC) is less than marginal revenue (MR), additional profit can still be extracted by producing an additional unit of output.
• The profit maximisation rule benefits shareholders as they receive dividends and an increase in the underlying share price, which increases their wealth.
• At the profit maximisation level of output, marginal cost (MC) equals marginal revenue (MR).
• Calculations can be used to demonstrate the profit maximisation rule by comparing marginal cost (MC) and marginal revenue (MR) at different levels of output. The difference between MC and MR determines the addition to profit.
• To determine the profit maximisation level of output from a diagram, identify where marginal cost (MC) equals marginal revenue (MR) and extend the dotted line upwards to the point where it hits the average revenue (AR) curve. This is the selling price (P1).\
• The profit maximisation rule states that firms aim to maximise profits by producing at a level where marginal cost (MC) equals marginal revenue (MR).
• The profit maximisation level of output often results in high prices for consumers.
• In the long term, firms will seek to adjust prices to the profit maximisation level of output. They may be forced to change prices by the government competition regulator.
• To determine the level of profit from a diagram, identify where marginal cost (MC) equals marginal revenue (MR) and then extend the dotted line upwards to the point where it hits the average revenue (AR) curve. This is the selling price. The difference between the selling price and the average cost represents the profit.
• Firms may find it difficult to produce at the profit maximisation level of output because they may not know where this level is. In the short term, they may not adjust their prices if the marginal cost changes, and in the long term, they may be forced to change prices by the government competition regulator.