DP Economics HL 2.11 Market Failure: Market Power

DP Economics HL 2.11 Market Failure: Market Power - Full notes

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DP Economics HL | 2.11 Market Failure: Market Power

DP ECONOMICS · UNIT 2: MICROECONOMICS

2.11

Market Failure: Market Power

Full notes for HL · IB-style

Contents

1	Costs, revenues and profit
2	The profit-maximizing rule and other goals
3	Perfect competition
4	Monopoly
5	Monopolistic competition
6	Oligopoly and game theory
7	Market power as market failure and government responses
8	Costs of production: definitions
9	Revenue concepts
10	Profit maximization: MC = MR
11	Normal and abnormal profit
12	Perfect competition
13	Monopoly
14	Barriers to entry
15	Natural monopoly
16	Oligopoly
17	Game theory
18	Monopolistic competition
19	Regulating market power
20	Mixed review: worked problems
21	Additional exam-style practice
22	Market power and inequality
23	Common misconceptions and links
24	Exam-style question with markscheme
25	Check your understanding
26	Summary and topic map

These are full teaching notes. Read each section in order, try the Think about it question before you read on, and do every Quick check before moving to the next section.

Before you start

Rate yourself on each statement now, and again after you've worked through the notes. Shade R (not yet), A (getting there) or G (confident).

I can…	R	A	G
explain the relationships between total, average and marginal cost and revenue
explain economic profit, normal profit and losses
explain the profit-maximizing rule MC = MR
compare perfect competition, monopolistic competition, oligopoly and monopoly
draw and explain a profit-maximizing monopoly diagram
explain collusion, cartels and game theory in oligopoly
explain why market power leads to allocative inefficiency and welfare loss
evaluate competition policy, regulation and other responses to market power

2.11 is entirely Additional Higher Level content. It is not part of the SL course.

Guiding questions

Why can some firms charge high prices year after year without losing customers? Why do a few large firms dominate many industries? Should governments break up big firms?

How this topic is examined

Market power is a major HL topic. Paper 1 asks you to explain a market structure with a diagram and evaluate government responses. Paper 3 asks you to calculate revenue, cost and profit from data and identify the profit-maximizing output.

The most important diagram is the profit-maximizing monopoly: practise it until you can draw it accurately without notes, with MC, AC, AR and MR, the output Qm, price Pm and the abnormal profit area.

Command term	What the examiner wants
Define	the precise meaning, ideally in the IB wording, in one or two sentences
Draw / Sketch	a fully labelled diagram with every axis, curve, equilibrium and change labelled
Explain	a causal chain linked to economic theory, usually supported by a diagram
Analyse	break a situation into its parts and trace the effects of each
Evaluate / Discuss	weigh up arguments, question assumptions and reach a justified conclusion using real-world examples
Calculate	use the cost and revenue formulas step by step and state output, price and profit

How to use these notes

Each section teaches one part of the syllabus in full. You'll see these boxes throughout; each has one job:

Box	What it's for
Think about it	a question to get you thinking before a section; the answer comes in the section
Key point	the one idea you must not forget
Common mistake	an error examiners see every year, and how to avoid it
In the real world	where the economics shows up outside the classroom
Try this	something quick you can do yourself to test the idea
Worked example	full solutions with IB-style marks (M1 method, A1 answer, R1 reasoning)
Quick check	short questions to test yourself at the end of each section

1 Costs, revenues and profit

Profit is the difference between what a firm earns and what it spends, including the cost of the owner's time and capital.

Think about it

A café owner earns $40 000 a year in profit after paying all her bills. She could earn $50 000 working for someone else. Is her business really profitable?

1.1 Costs

Total cost (TC) is the full cost of producing a given output. It includes fixed costs, which do not change with output in the short run (rent, insurance, machinery), and variable costs, which rise with output (raw materials, hourly wages, energy).

Average cost (AC) is cost per unit: AC = TC ÷ Q. Marginal cost (MC) is the extra cost of producing one more unit: MC = ΔTC ÷ ΔQ. In the short run, MC eventually rises because of diminishing marginal returns (2.2). The MC curve cuts the AC curve at its lowest point: when the cost of an extra unit is below the average, it pulls the average down; when it is above, it pulls the average up.

1.2 Revenues

Total revenue (TR) = price × quantity. Average revenue (AR) = TR ÷ Q, which equals the price, so the AR curve is the firm's demand curve. Marginal revenue (MR) = ΔTR ÷ ΔQ, the extra revenue from selling one more unit.

If a firm is a price taker (perfect competition), it can sell any amount at the market price, so AR = MR = P: a horizontal line. If a firm faces a downward-sloping demand curve, it must lower the price to sell more, including on all the units it was already selling, so MR is less than AR, and the MR curve slopes down twice as steeply as a straight-line AR curve.

1.3 Economic profit

Economists include opportunity costs in costs. Normal profit is the minimum profit needed to keep a firm in its industry: the return the owner could get from the next best use of their time and capital. It is counted as part of total cost. So when TR = TC, the firm earns normal profit (zero economic profit). When TR > TC, it earns abnormal (supernormal) profit. When TR < TC, it makes an economic loss.

In the café example, the owner's $40 000 accounting profit is less than the $50 000 she could earn elsewhere, so she is making an economic loss of $10 000.

Profit = TR − TC AC = TC ÷ Q AR = TR ÷ Q = P MC = ΔTC ÷ ΔQ MR = ΔTR ÷ ΔQ

Quick check

1. Define marginal cost.

2. Why is AR equal to price?

3. What is normal profit?

Answers: 1. the extra cost of one more unit 2. TR ÷ Q = (P × Q) ÷ Q = P 3. the minimum return to keep the firm in the industry; TR = TC

2 The profit-maximizing rule and other goals

Produce every unit that adds more to revenue than to cost.

A firm maximizes profit by producing the output at which marginal cost equals marginal revenue (MC = MR). Below that output, MR > MC, so each extra unit adds more to revenue than to cost and raises profit. Beyond that output, MC > MR, so each extra unit reduces profit.

In the short run, a firm should continue producing even at a loss as long as revenue covers its variable costs (price ≥ average variable cost), because it must pay fixed costs anyway. If price falls below average variable cost, it should shut down. In the long run, a firm must cover all costs, so it leaves the industry if it cannot earn at least normal profit.

As you saw in 2.4, firms may pursue other goals: revenue maximization (MR = 0), market share, growth, or corporate social responsibility.

Output	TR ($)	TC ($)	Profit ($)	MR	MC
0	0	20	-20
1	18	26	-8	18	6
2	32	30	2	14	4
3	42	36	6	10	6
4	48	46	2	6	10
5	50	60	-10	2	14
6	48	80	-32	-2	20

WORKED EXAMPLE 1 Finding maximum profit

Use the table to find the profit-maximizing output, and show that it is where MC and MR are closest to equal.

Solution

Profit = TR − TC: −20, −8, 2, 6, 2, −10, −32M1

Maximum profit is $6 at 3 unitsA1

At unit 3, MR = 10 and MC = 6 (MR > MC, so produce it); at unit 4, MR = 6 and MC = 10 (MC > MR, so don't)R1

Quick check

1. State the profit-maximizing rule.

2. When should a firm shut down in the short run?

Answers: 1. MC = MR 2. when price is below average variable cost

3 Perfect competition

Many small firms, identical products, free entry: no market power at all.

Perfect competition is a market structure with very many small firms selling an identical (homogeneous) product, with perfect information and no barriers to entry or exit. No single firm can influence the price: each is a price taker and faces a perfectly elastic (horizontal) demand curve at the market price.

In the short run, firms can make abnormal profits or losses. But if firms are making abnormal profits, new firms enter, market supply increases and the price falls until only normal profit is earned. If firms are making losses, some leave, supply falls and the price rises. In the long run, firms earn normal profit, and produce at the lowest point of their AC curve.

Perfect competition is allocatively efficient (P = MC: the price consumers pay equals the cost of the last unit) and productively efficient (production at minimum AC). Few real markets fit exactly; some agricultural and foreign-exchange markets come close. The model is a benchmark for judging other structures.

Quick check

1. List four characteristics of perfect competition.

2. Why do firms earn only normal profit in the long run?

3. Why is perfect competition allocatively efficient?

Answers: 1. many firms, identical products, perfect information, free entry and exit 2. abnormal profit attracts entry; price falls 3. P = MC

4 Monopoly

One firm, no close substitutes, high barriers: the firm sets its own price.

Think about it

Before mobile phones, many countries had a single, state-owned telephone company. What do you think happened to prices, service quality and innovation?

4.1 Characteristics and barriers to entry

A monopoly is a market with a single firm supplying a product with no close substitutes, protected by high barriers to entry. In practice, a firm with a very large market share (often above 25% to 40%) is said to have monopoly power. Because it is the market, the monopolist faces the downward-sloping market demand curve and is a price maker.

Monopoly power lasts only if other firms cannot enter. Barriers to entry include: economies of scale (a large firm has much lower average costs than any new entrant could); legal barriers such as patents, licences and copyrights; control of essential resources; high set-up costs; brand loyalty built through advertising; and aggressive tactics against entrants, such as predatory pricing.

4.2 The profit-maximizing monopoly

Figure 1. A profit-maximizing monopoly: output Qm where MC = MR, price Pm from the demand (AR) curve, abnormal profit shaded.

Build the diagram step by step. The demand curve is the monopolist's AR curve. MR lies below it. The firm produces where MC = MR, at output Qm. It then charges the highest price consumers will pay for that output, found by going up to the AR curve: price Pm. Average cost at Qm is found on the AC curve. Because Pm is above AC, the firm earns abnormal profit equal to (Pm − AC) × Qm, the shaded rectangle.

Because of barriers to entry, no new firms can enter to compete this profit away, so the monopolist can earn abnormal profit in the long run.

4.3 Monopoly and efficiency

Compared with perfect competition, a monopoly produces less output at a higher price. At Qm, the price consumers pay (Pm) is above marginal cost: consumers value an extra unit more than it would cost to produce, but the monopolist doesn't produce it, because doing so would reduce its profit. The monopoly is allocatively inefficient (P > MC), and there is a welfare loss. It is also usually not productively efficient, and lack of competition may lead to X-inefficiency: costs higher than necessary because there is no pressure to control them.

But monopoly can have benefits. Economies of scale can mean lower costs than many small firms could achieve. Abnormal profits can fund research and development, leading to new products (dynamic efficiency); pharmaceutical patents are designed on this logic. A natural monopoly exists where economies of scale are so large that one firm can supply the whole market at a lower cost than two or more firms, as with water and electricity networks; splitting it would raise costs.

Quick check

1. Name three barriers to entry.

2. How does a monopolist choose its price?

3. Why is monopoly allocatively inefficient?

4. Define natural monopoly.

Answers: 1. economies of scale, patents, control of resources, brand loyalty 2. produce at MC = MR, then read price from AR 3. P > MC 4. one firm can supply the market more cheaply than several because of economies of scale

5 Monopolistic competition

Many firms, slightly different products: some power in the short run, none in the long run.

Monopolistic competition has many firms selling differentiated products, with low barriers to entry. Restaurants, hairdressers, clothing shops and cafés are typical. Each firm's product is slightly different (location, style, brand, quality), so each faces a downward-sloping demand curve and has a little price-setting power.

In the short run a firm can make abnormal profit. But because entry is easy, new firms are attracted, taking customers away and shifting each firm's demand curve left until only normal profit remains in the long run. Firms compete heavily through non-price competition: advertising, branding, product design and customer service.

Monopolistic competition is not allocatively efficient (P > MC) and firms do not produce at minimum AC, so there is some excess capacity, but consumers gain from variety and choice.

Quick check

1. Give two features of monopolistic competition.

2. Why is long-run profit only normal?

Answers: 1. many firms, differentiated products, low barriers 2. easy entry competes profits away

6 Oligopoly and game theory

A few large firms, each watching the others.

An oligopoly is a market dominated by a few large firms, with high barriers to entry. Products may be identical (oil, steel) or differentiated (cars, smartphones, supermarkets). The defining feature is interdependence: each firm's best decision depends on what its rivals do, so firms must think strategically.

The degree of dominance is often measured by a concentration ratio: the combined market share of the largest firms. A four-firm concentration ratio (CR4) of 80% means the four largest firms hold 80% of the market.

Oligopolists can compete, cutting prices or spending heavily on advertising, or they can collude: cooperate to restrict output and raise prices, acting like a joint monopoly. Formal collusion in a cartel (for example, an agreement on prices or market shares) is illegal in most countries, though OPEC is an international cartel of oil-producing countries. Tacit collusion happens without a formal agreement, for example when firms follow a price leader.

6.1 Game theory

Game theory analyses strategic decisions where each player's outcome depends on others' choices. The prisoner's dilemma shows why collusion is unstable. Two firms can each charge a high price or a low price. If both charge high, both earn good profits. But each has an incentive to cheat by cutting its price and taking customers from the other. If both cheat, both end up worse off than if they had cooperated.

	Firm B: high price	Firm B: low price
Firm A: high price	A $10m, B $10m	A $2m, B $14m
Firm A: low price	A $14m, B $2m	A $5m, B $5m

Whatever B does, A earns more by charging a low price ($14m > $10m if B charges high; $5m > $2m if B charges low). The same is true for B. So both choose low prices and earn $5m each, even though both would earn $10m by cooperating. This is why cartels tend to break down, and why firms in oligopoly often prefer non-price competition, which avoids damaging price wars.

Quick check

1. What is interdependence in oligopoly?

2. What is a cartel?

3. Why does the prisoner's dilemma make collusion unstable?

Answers: 1. each firm's decisions depend on rivals' reactions 2. a formal agreement to restrict output or fix prices 3. each firm gains by cheating, whatever the other does

7 Market power as market failure and government responses

Market power reduces output and raises prices; governments try to limit its abuse.

Market power is a market failure because firms with power restrict output and raise price above marginal cost, so too little is produced compared with the allocatively efficient level. Consumers lose surplus, some of which becomes the firm's profit and some of which is a deadweight welfare loss.

Governments respond in several ways.

Policy	How it works	Example	Limitation
Competition law	bans abuse of dominance and cartels; fines	EU fines on Google for abusing search dominance	slow, hard to prove tacit collusion
Merger control	blocks mergers that reduce competition	competition authorities blocking supermarket mergers	may block efficient mergers
Price regulation	caps prices of natural monopolies	price caps on water and energy networks	regulator lacks information; regulatory capture
Breaking up firms	splits a monopoly into competing firms	break-up of AT&T in the US (1984)	loss of economies of scale
Nationalization	state ownership of natural monopolies	state-owned railways	may be inefficient; political influence

In the real world

In 2018 the European Commission fined Google €4.34 billion for using its Android operating system to strengthen the dominance of its search engine. Competition authorities around the world are now examining the market power of large technology platforms.

8 Costs of production: definitions

Fixed, variable, total, average, marginal.

Cost	Meaning
fixed cost (FC)	does not vary with output (rent)
variable cost (VC)	varies with output (raw materials)
total cost (TC)	FC + VC
average total cost (ATC)	TC/Q
marginal cost (MC)	change in TC from producing one more unit

WORKED EXAMPLE 2 Calculations (standard)

FC = $100; producing 10 units costs VC = $150. Find TC and ATC.

Solution

TC = $250A1

ATC = $25A1

9 Revenue concepts

Total, average, marginal.

Total revenue TR = P × Q; average revenue AR = TR/Q = P; marginal revenue MR = change in TR from selling one more unit. For a perfectly competitive firm, P = AR = MR; for a firm with market power, MR < AR.

Q	P	TR	MR
1	10	10	10
2	9	18	8
3	8	24	6
4	7	28	4
5	6	30	2

WORKED EXAMPLE 3 MR (standard)

Using the table, explain why MR falls faster than price.

Solution

To sell more, the firm lowers price on all unitsR1

MR = price of extra unit minus revenue lost on previous unitsR1

10 Profit maximization: MC = MR

The rule.

Firms maximize profit where marginal cost equals marginal revenue (and MC is rising). Producing less leaves profitable units unsold; producing more adds units costing more than they earn.

WORKED EXAMPLE 4 Rule (exam level)

A firm's MR is $15 and MC is $11 at its current output. Should it change output?

Solution

MR > MC: each extra unit adds $4 profitR1

Increase output until MC = MRA1

11 Normal and abnormal profit

Economic profit.

Normal profit is the minimum profit needed to keep a firm in the industry (included in costs as opportunity cost). Abnormal (supernormal) profit is profit above normal profit: AR > ATC. Losses occur when AR < ATC.

WORKED EXAMPLE 5 Profit (standard)

At the profit-maximizing output of 200 units, P = $30 and ATC = $24. Calculate abnormal profit.

Solution

(30 − 24) × 200M1

= $1200A1

12 Perfect competition

Price takers.

Many small firms selling identical products, perfect information, and free entry and exit. Firms are price takers. In the long run, abnormal profits attract entry, so firms earn only normal profit, and the market is allocatively (P = MC) and productively (minimum ATC) efficient.

WORKED EXAMPLE 6 Long run (exam level)

Explain why firms in perfect competition earn only normal profit in the long run.

Solution

Abnormal profit attracts new firms (no barriers)R1

Market supply rises, price falls until P = minimum ATCR1

13 Monopoly

One dominant seller.

A monopoly is a single seller with high barriers to entry and no close substitutes. It maximizes profit where MC = MR, charging a higher price and producing less than a competitive market, creating a welfare loss. Abnormal profits can persist in the long run.

Figure 2. A profit-maximizing monopoly sets output where MC = MR.

WORKED EXAMPLE 7 Welfare (exam level)

Explain why monopoly is allocatively inefficient.

Solution

Produces where MC = MR, so P > MCR1

Output below the level where MSB = MSC: welfare lossR1

14 Barriers to entry

Keeping competitors out.

Barriers include economies of scale, legal barriers (patents, licences), control of essential resources, high start-up costs, brand loyalty, and anti-competitive behaviour (predatory pricing).

Quick check

1. Name two barriers to entry in the pharmaceutical industry.

Answers: 1. patents; high research costs

15 Natural monopoly

One firm is cheapest.

A natural monopoly exists when economies of scale are so large that one firm can supply the whole market at lower average cost than several firms (water, electricity grids, railways). Governments often regulate or nationalize them.

Quick check

1. Why is it inefficient to have several water supply networks in one town?

Answers: 1. duplication of very high fixed costs

16 Oligopoly

A few interdependent firms.

Oligopolies have a few large firms with high concentration (supermarkets, airlines, smartphones). Firms are interdependent: each must consider rivals' reactions. They may compete on non-price factors, collude (cartels such as OPEC), or engage in price wars.

WORKED EXAMPLE 8 Concentration ratio (standard)

The four largest firms have market shares of 28%, 22%, 15% and 10%. Calculate the 4-firm concentration ratio.

Solution

28 + 22 + 15 + 10M1

= 75%: oligopolyA1

17 Game theory

Strategic decisions.

Game theory models oligopoly decisions using payoff matrices. In the prisoner's dilemma, each firm's dominant strategy (cut price) leads to a worse joint outcome than cooperating, which explains why collusion is tempting but unstable.

	Firm B: high price	Firm B: low price
Firm A: high price	A 10, B 10	A 2, B 14
Firm A: low price	A 14, B 2	A 5, B 5

WORKED EXAMPLE 9 Payoff matrix (exam level)

Identify the dominant strategy and the outcome.

Solution

Low price is dominant for both (14 > 10; 5 > 2)R1

Outcome: both low (5, 5), worse than both high (10, 10)R1

18 Monopolistic competition

Many firms, differentiated products.

Many firms sell differentiated products (restaurants, hairdressers) with low barriers. In the short run, firms may earn abnormal profits; in the long run, entry reduces each firm's demand until only normal profit is earned.

Quick check

1. Why do restaurants spend on branding?

Answers: 1. to differentiate and make demand less elastic

19 Regulating market power

Competition policy.

Governments use competition (anti-trust) laws to prevent collusion, block mergers that reduce competition, regulate prices of natural monopolies, and break up dominant firms. Large fines are imposed on cartels.

In the real world

In 2018 the European Commission fined Google 4.3 billion euros for abusing the dominance of Android to favour its own search engine.

Quick check

1. Give two policies to reduce market power.

Answers: 1. blocking mergers; price regulation; fines for collusion

20 Mixed review: worked problems

Bringing the ideas together.

WORKED EXAMPLE 10 Mixed problem (exam level)

Using the revenue table, if MC = $4 constant, find the profit-maximizing output.

Solution

MR = MC at Q = 4 (MR = 4)M1 A1

Price = $7A1

21 Additional exam-style practice

Paper 1 and Paper 3.

WORKED EXAMPLE 11 Paper 1 part (b) (exam level)

Evaluate the view that monopoly is always against the public interest. [15]

Solution

Higher prices, lower output, welfare loss (diagram)R1 R1

Economies of scale, R&D from abnormal profit (dynamic efficiency)R1

Regulation; judgementR1 R1

22 Market power and inequality

Profits and wages.

Market power can increase inequality: abnormal profits flow to shareholders, and monopsony power in labour markets can hold down wages. Rising concentration in some industries has been linked to falling labour shares of income.

Quick check

1. What is monopsony?

Answers: 1. a single dominant buyer, e.g. of labour

23 Common misconceptions and links

Students often think…	Actually…
monopolists charge the highest possible price	they choose the price that maximizes profit, where MC = MR
price is where MC cuts MR	price is read from the AR curve above Qm
normal profit is zero profit in accounting terms	it is the opportunity cost of the owner's resources
all monopolies are harmful	natural monopolies and R&D can bring benefits
oligopolists always collude	the prisoner's dilemma makes collusion unstable

How 2.11 connects to the rest of the course

Topic	Connection
2.2 Supply	diminishing returns and rising MC
2.3 Equilibrium	welfare loss from restricted output
2.4 Firm objectives	profit vs revenue maximization
4.4 Economic integration	competition in larger markets

24 Exam-style question with markscheme

Try this under exam conditions (about 18 minutes) before reading the markscheme.

Figure 3. Market shares in a country's mobile network market.

Text A. Four firms dominate the mobile network market. Prices have barely changed for five years, and firms compete mainly through advertising and data offers. Firms A and B have proposed a merger.

(a) Calculate the four-firm concentration ratio. [1]

(b) Identify the market structure and explain two of its features. [3]

(d) Using a diagram, explain why the competition authority might block the merger. [4]

(e) A firm's MR = 50 − 2Q and MC = 10 + 2Q. Calculate the profit-maximizing output. [2]

Markscheme

Part	Answer	Marks
(a)	38 + 27 + 15 + 10 = 90%	A1
(b)	oligopoly	A1
	few dominant firms / interdependence / high barriers	R1 R1
(c)	price cuts would be matched	R1
	price wars reduce all firms' profits	R1
	advertising and offers build loyalty without cutting prices	R1
(d)	diagram: monopoly with P > MC and welfare loss	A1
	merged firm would hold 65% of the market	R1
	more market power: higher prices, lower output	R1
	allocative inefficiency / less consumer choice	R1
(e)	50 − 2Q = 10 + 2Q	M1
	Q = 10	A1

Examiner's comments. In (d), many diagrams read the price from the MR curve. Price is always found by going up to the AR curve at the profit-maximizing output.

25 Check your understanding

Section A: multiple choice

1. Profit is maximized where

A. marginal cost equals marginal revenue B. average cost is lowest C. total revenue is highest D. price equals average cost

2. Abnormal profit occurs when

A. revenue equals cost B. price equals AVC C. total revenue exceeds total cost D. MR = 0

3. In perfect competition in the long run, firms earn

A. abnormal profit B. normal profit C. losses D. zero revenue

4. A natural monopoly exists when

A. a firm owns a natural resource B. the government bans competition C. demand is elastic D. one firm can supply the market at the lowest cost

5. Allocative efficiency requires

A. MC = MR B. P = MC C. P = AC D. MR = 0

6. An oligopoly is characterized by

A. a few large interdependent firms B. many firms C. one firm D. no barriers to entry

7. A firm should shut down in the short run if price is below

A. average total cost B. marginal revenue C. marginal cost D. average variable cost

8. Monopolistic competition features

A. identical products B. one firm C. many firms with differentiated products D. high barriers

Section B: structured

9. Using a diagram, explain how a monopoly can earn abnormal profit in the long run. [6]

10. Explain why collusion is difficult to maintain in an oligopoly. [4]

11. Evaluate the view that monopoly power is always against the public interest. [8]

12. TR is 18, 32, 42 and 48 at outputs 1 to 4; TC is 26, 30, 36 and 46. Find the profit-maximizing output. [2]

Answers

1. A 2. C 3. B 4. D 5. B 6. A 7. D 8. C

9. Diagram AR, MR, MC, AC; output where MC = MR; price from AR; profit rectangle; barriers to entry prevent new firms.

10. Prisoner's dilemma: each firm gains by cheating; detection difficult; illegality; new entrants.

11. Against: higher price, lower output, welfare loss, X-inefficiency; for: economies of scale, R&D, natural monopoly; regulation; judgement.

12. Profit −8, 2, 6, 2: output 3, profit $6.

26 Summary and topic map

Idea	Remember
Profit	TR − TC; normal profit when TR = TC
Rule	maximize profit where MC = MR
Perfect competition	price takers; normal profit in the long run; P = MC
Monopoly	price maker; barriers; abnormal profit; P > MC
Monopolistic competition	differentiated products; normal profit in the long run
Oligopoly	few firms; interdependence; collusion vs competition
Policy	competition law, merger control, price regulation, break-ups

Before the exam, make sure you…

•draw the monopoly diagram with MR below AR and price read from AR
•shade abnormal profit as (P − AC) × Q
•explain barriers to entry precisely
•use the prisoner's dilemma to explain cartel instability
•evaluate both costs and benefits of market power

Market Power on one page

Cover this page with a sheet of paper and try to rebuild it from memory. Whatever you can't recall is what to revise next.

Figure 4. Topic map for Market Power.

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