Market failure: market power

The ability of a firm (or group of firms) to influence the PRICE of a good or service. A firm with market power is a PRICE MAKER — it can raise prices above the competitive level, restrict output, and earn abnormal (supernormal) profits in the long run.

A firm with market power produces where MR = MC, but charges a price on the demand curve that is ABOVE MC. Since P > MC, the last unit consumed is valued more than it costs to produce, meaning resources are under-allocated to this market.

Obstacles that make it difficult for new firms to enter a market and compete with existing firms. They protect incumbents' market power and profits. Without barriers, supernormal profits would attract new firms, increasing competition and driving profits to normal levels.

1) Economies of scale — incumbent's low average cost deters entry. 2) High start-up costs. 3) Legal barriers — patents, licences. 4) Brand loyalty — consumers locked in. 5) Control of supply chains/distribution. 6) Predatory pricing — temporarily cutting prices below cost to drive entrants out.

1) High market concentration — few firms control most of the market (oligopoly/monopoly). 2) Product differentiation — branding/quality makes products seem unique. 3) Control of essential resources (e.g. De Beers and diamonds). 4) Legal barriers — patents, copyrights, licences.

The loss of total surplus because the firm produces less than the socially optimal quantity. Some mutually beneficial trades don't happen. On a diagram, it is the triangle between the demand curve, MR curve, and MC curve, from the monopoly output to the competitive output.

The incumbent firm produces at such large volume that its average cost is very low. A new entrant, starting small, has much higher average costs and cannot match the incumbent's prices. This makes entry unprofitable and effectively blocks new competition.

In perfect competition, no single firm can affect the price — all are price TAKERS selling identical products. With market power, firms can set prices above marginal cost, restrict output, and earn supernormal profits because consumers have fewer alternatives.

The firm charges a higher price and sells a lower quantity than in a competitive market. Consumer surplus shrinks — the area above the price line and below demand is smaller. Some of the lost consumer surplus is transferred to the firm as producer surplus (profit); the rest is deadweight loss.

Profits above the normal return needed to keep a firm in business. In competitive markets, supernormal profits attract entry and are competed away. With market power, barriers to entry prevent this, so firms can sustain supernormal profits in the long run.

When a firm with market power does not minimise its costs because it faces no competitive pressure. Without the threat of rivals, there is less incentive to control waste, innovate processes, or push for productivity. This is also called productive inefficiency from complacency.

When an incumbent firm temporarily cuts prices below cost to drive new entrants (or small competitors) out of the market. Once competitors exit, the firm raises prices again and recaptures its monopoly power. This is illegal in most jurisdictions.

Without barriers, supernormal profits attract new firms into the market → supply increases → price falls → profits return to normal. Barriers prevent this competitive process, allowing incumbent firms to maintain high prices and profits in the long run.

By making products seem unique through branding, quality, design, or features, firms reduce the substitutability of their product. Consumers become less price-sensitive (demand becomes more inelastic), giving the firm power to charge higher prices without losing all customers.

Draw D (downward-sloping), MR (below D, twice as steep), and MC. Monopoly output at MR = MC. Price read off the D curve at that quantity. Competitive output at D = MC. Shade: DWL triangle between monopoly and competitive output, bounded by D and MC.

Government laws and regulations designed to promote competition, prevent abuse of market power, and protect consumer interests. Also called antitrust policy. Tools include anti-monopoly legislation, merger regulation, break-ups, and fines for anti-competitive behaviour.

An industry where the minimum efficient scale is so large relative to market demand that only ONE firm can produce at the lowest average cost. Having two firms would duplicate expensive infrastructure (water pipes, railway tracks, electricity grids), raising costs for everyone.

1) Can lower prices for consumers. 2) Increases choice and product variety. 3) Improves efficiency (competitive pressure reduces waste). 4) Merger regulation prevents harmful consolidation before it occurs. 5) Fines deter anti-competitive behaviour.

1) Anti-monopoly legislation — prevents abuse of dominant position. 2) Merger regulation — reviews/blocks mergers that reduce competition. 3) Breaking up monopolies — forces a monopoly to split into smaller firms. 4) Fines — punishes price-fixing, market-sharing, and predatory pricing.

1) Authorities may lack information to distinguish competitive from anti-competitive behaviour. 2) Regulation is costly and firms may "game" the rules (regulatory capture). 3) Breaking up firms can reduce economies of scale. 4) Nationalisation may cause productive inefficiency (no profit motive).

Breaking it up would RAISE costs because each smaller firm would need its own infrastructure (duplicate water pipes, railway lines). One firm producing for the whole market achieves the lowest average cost. The solution is to REGULATE the monopoly, not break it up.

When a regulatory body becomes dominated by the industry it is supposed to regulate. Firms lobby the regulator, provide information selectively, or offer jobs to ex-regulators. The regulator ends up serving the industry's interests rather than the public's.

1) Price regulation — set maximum price (often P = AC for normal profit). 2) Rate-of-return regulation — cap the allowed rate of profit. 3) Quality standards — prevent the firm from cutting quality. 4) Nationalisation — state owns and operates the monopoly directly.

In 2024, the EU fined Apple €1.84 billion for abusing its dominant position in music streaming — Apple prevented Spotify and others from telling users about cheaper subscription options outside the App Store, limiting consumer choice.

To prevent harmful consolidation BEFORE it happens. If two large firms merge, the combined entity may have excessive market power, raise prices, and reduce consumer choice. Competition authorities assess whether the merger would "significantly reduce competition" and can block it.

Supernormal profits fund research and development (R&D), leading to innovation that benefits consumers in the long run. Without the prospect of monopoly profits, firms may lack the incentive to invest in risky new technologies. The goal isn't to eliminate market power but to prevent its abuse.

1) Water supply — one set of pipes serves a region. 2) Electricity grids — one network distributes power. 3) Railway networks — duplicate tracks would be wasteful. 4) Gas pipelines — massive infrastructure with huge economies of scale.

Weigh consumer harm (higher prices, lower output, DWL) against potential benefits (innovation, EoS, R&D). Discuss specific policies (competition law, regulation, nationalisation) and their limitations. Conclude: the goal is to prevent ABUSE while harnessing the benefits of scale and innovation.

The firm has a natural cost advantage (one set of infrastructure), so competition is inefficient. But without regulation, the firm can charge monopoly prices and earn supernormal profits. Governments must balance: allow the cost efficiency of one firm while preventing price abuse.

Price-fixing is when competing firms secretly agree to set prices at an agreed level rather than competing. It eliminates price competition, keeps prices artificially high, and harms consumers. It is a form of collusion and is punishable by large fines in most countries.