Market Power

Cards (41)

  • Market Failure
    • Refers to the failure of the market to allocate resources efficiently
    • When allocative efficiency is not achieved resulting in under or overallocation of resources (not socially optimal)
  • Allocative inefficiency
    Market failure results in allocative inefficiency, where too much (overallocation of resources); or too little (underallocation of resources) of goods or services are produced and consumed from the point of view of what is socially most desirable.
    • i.e. Resources not allocated efficiently, equilibrium is not achieved & there is dead weight loss ==> market failure & allocative inefficiency
  • Allocative efficiency is achieved when D=S or when MB = MC
  • Marginal Benefit: MB
    Benefits received by consumers for consuming one more unit of the good
  • Marginal Cost: MC
    Cost to producers of producing one more unit of the good
  • Competitive Market:
    • Competition for market share
    • Allocative efficiency is achieved
    • Total surplus is maximised
    • Homogenous products
    • Large number of buyers and sellers
    • No market power: Price takers
    • No barriers to enter or exit market
  • Imperfect Market:
    • Some to No Competition for market share
    • Allocative inefficiency is achieved
    • DWL is present
    • Differentiate products, but are still close substitutes
    • Small number of buyers and sellers
    • Market Power: Price setters
    • Barriers to enter or exit market
  • Perfect Competition
    • Homogenous products - sells similar products at similar prices, therefore lots of competition
    • Large number of buyers and sellers
    • No market power, firms can't set price, take price that is set by market
    • Price takers, allocative efficiency is achieved
    • No barriers to enter or exit market
    • E.g. Agricultural market
  • Monopoly
    • One firm
    • No close substitutes for product
    • Firms are price setters, have to pay the price if they want the product as they can't go anywhere else
    • High barriers to entry
    • E.g. Utilities (water, energy)
    • No substitutes
    • Hard to set up, equipment
    • Usually controlled by government to prevent
  • Oligopoly
    • Few large firms
    • Goods are close substitutes
    • Barriers to entry exit
    • Sellers are interdependent - engage in strategic behaviour
    • All raise prices together, price setters
    • E.g. Supermarkets (coles, woolies, IGA, Aldi)
    • Similar products and price ranges
  • Monopolistic competition
    • Similar to competitive markets but different in the sense that there are product differentiation: physical, quality and location
    • Many firms
    • Differentiate products, but are still close substitutes
    • Lower barriers to entry
    • Information is imperfect - sellers know more about product, consumers don't know true value/cost
    • Firms are price setters
    • E.g. Phone industry, computers
  • Barriers to Entry:
    • Economies of scale: permitting lower average costs to be achieved as the firm increases its size
    • Average total costs of a large firm are substantially lower than the average costs faced by a smaller firm
    • Larger firms can afford machinery to make things in bulk
    • Large firm can charge a lower price than the smaller firm, and force the smaller  firm into a situation where it will not be able to cover its costs
  • Barriers to Entry:
    • Branding: creation by a firm of a unique image and name of a product
    • Advertising campaigns that try to influence consumer tastes in favour of the product, attempting to establish consumer loyalty.
    • Does not lead to monopolies, methods used by oligopoly and monopolistic competition
    • E.g. apple products
  • Barriers to Entry: Legal:
    • Patents: rights given by the government to a firm that has developed a new product or invention to be its sole producer for a specified period of time
    • They will have a monopoly during this time e.g. patents on new pharmaceutical products
    • Does not lead to monopoly buy limit competition
  • Barriers to Entry: Legal:
    • Licenses: granted by governments for particular professions or particular industries
    • E.g. license may be required to operate a radio or television station
  • Barriers to Entry: Legal:
    • Copyrights: guarantee that an author has the sole rights to print, publish and sell copyrighted work
  • Barriers to Entry: Legal:
    • Public franchises: granted by the government to a firm which is to produce or supply a particular good or service
  • Barriers to Entry: Legal:
    • Tariffs, quotas and other trade restrictions: limit the quantities of a good that can be imported into a country, thus reducing competition
  • Barriers to Entry:
    • Control of essential resources: monopolies can arise from ownership or control of an essential resource
    • E.g. DeBeers, the South African diamond firm, that mines roughly 50% of the world’s diamonds and purchases about 80% of diamonds sold on open markets
  • Barriers to Entry:
    • Aggressive tactics: when existing firms use tactics to discourage new firms from entering the market
  • Anti-competitive behaviour: Agreements or arrangements between firms that seek to restrain competition and remove the automatic regulation that competitive markets achieve.
  • Price Fixing
    A practice whereby rival companies come to an illicit agreement not to sell goods or services below a certain price
  • Market Sharing
    A market is divided into a series of smaller markets, each supplied by one of the firms, thus reducing competition
  • Cartel
    When firms agree to act or collude together instead of competing with each other – includes both price fixing and market sharing
  • Collusion
    General term describing agreements between firms – either price or market sharing – to reduce competition and increase profits
  • Collusive Tendering

    Firms agree to submit exorbitant tenders which ensure high profits and the sharing of work between the collusive members
  • Predatory pricing
    When a company with substantial market power sets is prices at a sufficiently low level with the purpose of eliminating or substantially damaging a competitor
  • Resale price maintenance
    The supplier sets the price at which a retailer must sell its products. The manufacturer may refuse to sell to any retailer which may resell their products at a discount
  • Exclusive dealing
    When one person trading with another imposes some restrictions on the other's freedom to choose which whom or where they deal
  • Collective boycott

    When a group of competitors agree not to acquire goods or services from, or not to supply goods or services to, a business with whom the group is negotiating
  • Merger
    Two or more firms join together to form one larger firm – prohibited if it substantially reduces competition in the market
    • A firm has market power if it is able to affect the market price by varying output
    • The lower the number of firms, the more market power the remaining firms have
  • Policy Options to Correct Market Failure:
    Regulation
    • If there is a natural monopoly, it is not in society’s interest to break it up into smaller firms, as this would result in higher average costs and would be inefficient.
    • Governments usually regulate natural monopolies, to ensure more socially desirable price and quantity outcomes
    • Governments also control who enters the market
    • Goal is to benefit the most of society
  • Policy Options to Correct Market Failure:
    Deregulation
    • Too much regulation, firms can't be innovative, improve
    • Government regulations that restrict competition include:
    • Limiting the number or types of businesses
    • Limiting the ability of businesses to compete
    • Reduce the incentives for businesses to compete
    • Limiting the choice and information available to consumers
    • Some government regulations need to be de-regulated to enhance competition
  • Policy Options to Correct Market Failure:
    Legislation
    • Legislation: put in place to limit anti-competitive behaviours to achieve a greater degree of allocative efficiency
    • Example: ACCC: aims to protect, strengthen and supplement the way competition works in Australian markets and industries
    • They enforce the competition and consumer act 2010 and other legislation promoting competition and fair trading.
  • Purpose of the ACCC: Promote competition and fair trading
  • Market power will normally result in Increased producer surplus and decreased total surplus
  • Market failure occurs when the market fails to allocate resources efficiently, meaning allocative efficiency is not achieved, resulting in under or overallocation of resources, which is not socially optimal