Key Idea: Topic 2.11 explains how firms with market power can charge prices above marginal cost, creating allocative inefficiency and deadweight loss. It also covers competition policy as a response.
✅ Core definitions
- Market power
- A firm's ability to set prices above the competitive level — it is a price maker, not a price taker.
- Barriers to entry
- Obstacles preventing new firms from entering — economies of scale, patents, brand loyalty, high start-up costs.
- Allocative inefficiency
- P > MC — the firm restricts output below the socially optimal level, creating deadweight loss.
- Natural monopoly
- An industry where one firm can supply the whole market at lower cost than two or more (very high fixed costs, e.g. water, rail).
📊 Why market power is a problem
- Firms produce where MR = MC → charge P > MC → allocative inefficiency
- Consumer surplus falls (higher prices, less choice)
- Deadweight loss — output restricted below competitive level
- X-inefficiency — no competitive pressure → less incentive to minimise costs
🏛️ Policy responses
- Competition policy — anti-monopoly laws, merger regulation, break-ups, fines (Apple €1.84bn example)
- Regulation — price caps, rate-of-return regulation, quality standards
- Nationalisation — state ownership of natural monopolies (water, rail)
⚖️ Evaluation
✅ For intervention: Lower prices for consumers. Reduces deadweight loss. Prevents abuse of dominance.
❌ Against intervention: Information gaps (regulators know less than firms). Regulatory capture risk. May reduce innovation incentive (Schumpeter argument).
Schumpeter's counter-argument: market power can fund innovation through supernormal profits. Some monopoly power may actually be socially desirable.