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Market Failure — Market Power · Paper 2 — Free Economics HL Practice Questions
1MasteryLAQDefinition of market power10 marksPaper 2~15 min
Extract: In 2023, the global market for semiconductor chips used in artificial intelligence (AI) processing was dominated by a single firm, TechChip Inc., which held of the market. The next largest competitor held only . TechChip's chips were essential for training large AI models and no close substitutes existed. The average price of TechChip's flagship AI chip was USD 32,000, while the estimated marginal cost of production was USD 8,000. Despite rising demand from AI firms, TechChip had not significantly expanded production capacity. New entrants faced barriers including patents, high capital costs, and proprietary manufacturing processes.
(a)
State the formula for the Lerner Index and calculate its value for TechChip Inc. [2 marks]
(b)
Using a monopoly , explain how TechChip Inc. is able to earn supernormal profit and restrict output below the socially optimal level. [4 marks]
(c)
Evaluate whether the benefits of TechChip's market power outweigh its costs to consumers and to the wider economy. [4 marks]
Solutions
2MasteryLAQDefinition of market power10 marksPaper 2~15 min
The pharmaceutical company PharmaCorp holds the patent for a life-saving drug, CardioSave, used to treat a rare heart condition. The patent grants PharmaCorp exclusive production rights for 15 years. The annual course of treatment is priced at USD 120,000, while the marginal cost of production is USD 6,000. Demand is highly inelastic, as patients have no alternative treatments. In a neighbouring country, a generic manufacturer attempted to produce a cheaper version of CardioSave after the patent expired but faced years of legal challenges from PharmaCorp over minor patent extensions. The country's competition authority is considering imposing a price cap on CardioSave.
(a)
State the formula for the Lerner Index and calculate its value for CardioSave. [2 marks]
(b)
Explain three sources of market power that allow PharmaCorp to maintain its dominant position. [3 marks]
(c)
Evaluate the likely impact of a price cap on CardioSave on consumers and on PharmaCorp, and justify whether the competition authority should set the cap at marginal cost or at a level that allows normal profit. [5 marks]
Solutions
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