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48-Revision_Market_Power - AS Micro Unit 1 Economics...

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AS Micro Unit 1 Economics: Revision on Market Power Most markets are competitive with a number of suppliers (producers) competing for the demand of consumers. Some are more competitive than others. At AS level it is important to understand some of the factors that lead to market (monopoly) power and to evaluate the costs and benefits of markets where monopoly power exists together with the effects of different types of government intervention. In competitive markets 1. There are many suppliers, none of whom dominates the market (i.e. diluted rather than concentrated) 2. High cross price elasticity of demand – because consumers have plenty of choice / substitutes 3. Low barriers to entry and exit – new firms can enter the market if profits are high enough (incentives!) 4. Intense price and non-price competition – as firms battle for market share and dominance There are many occasions when competitive markets fail – e.g. when they fail to take into account externalities and where there is information failure. But there are also advantages from having sufficient competition: Lower prices - because of the large number of competing firms – improved allocative efficiency Firms attempt to minimize their costs per unit – improved productive efficiency Faster rate of technological progress and innovation – improved dynamic efficiency The case against monopoly power Monopolists earn extra profit at the expense of efficiency by setting prices above those that would exist in competitive markets. This can lead to a misallocation of resources e.g. loss of allocative efficiency If there is an oligopoly, the leading firms may engage in collusive behaviour designed to keep market prices higher than under competition Lack of competition might cause average costs to rise which leads to productive inefficiency If firms feel that competition is weak, there may be less pressure to be dynamically efficient
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When demand is price inelastic, firms with market power can raise prices well above cost and make higher profits. Competition within a market makes demand more price sensitive (see right-hand diagram)
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48-Revision_Market_Power - AS Micro Unit 1 Economics...

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