Market power

• Profit maximisation


  The objective of firms in imperfectly competitive markets
• Short-run decision


  Keep producing if price is greater than minimum average avoidable cost (variable costs + quasi-fixed costs)
• Long-run decision


  Keep producing if P > min LRAC
• Quasi-fixed costs


  Do not vary with output as long as output is positive
• Perfect Competition


  • Economies of scale are small relative to market size
  • Output is homogeneous
  • Perfect information
  • No barriers to entry or exit

  
• Quasi-rents


  Difference between TR and avoidable costs in short-run, providing a contribution towards firm's sunk costs
• Consumer surplus


  Amount consumer is willing to pay (WTP) - Actual price
• Producer surplus


  Price producer receives - Price producer has to pay to supply
• Total surplus


  Consumer surplus + Producer surplus, maximised where WTP = MC
• Pareto optimality


  An outcome where it is not possible to make one person better off without making another worse off
• Pareto improvement


  A move from allocation A to B that makes someone better off without making someone else worse off
• Potential Pareto improvement


  A move from A to B where the winners (who become better off) could compensate the losers (who become worse off) but do not
• Problems with assessing efficiency based on changes in total surplus

  • 1) CS is not an exact monetary measure of consumer welfare
  • 2) DD and SS curves may not capture all social costs and benefits (externalities)
  • 3) Distribution of gains from trade is not explicitly taken into account
• Market power


  A firm has market power if it finds it profitable to raise Price above MC (P > MC)
• Determinants of market power

  • Supply-side substitution (with identical products)
  • Demand-side substitution (with imperfect substitutes/differentiated products)
• Price-making firm


  Faces a downward sloping demand curve
• Inefficiency of monopoly pricing

  • Qs = socially optimum quantity where MC=Marginal benefit of consumption
  • At Qm, MB = WTP = P>MC → too few units produced
  • Deadweight loss = difference between TS under monopoly and maximum TS
  • Transfer of CS to firm as profits and loss of surplus as DWL
  • TS not maximised, so potential Pareto improvement is possible