Market Power

• 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