Market Failure: Market Power
Market power refers to the ability of a firm to influence the price of its product. In a monopoly, a single firm dominates the market and faces the entire market demand curve. Profit maximisation occurs where MR = MC, but this typically results in higher prices and lower output than in competitive markets, creating deadweight loss. Price discrimination allows monopolists to capture consumer surplus. Oligopolies are characterised by interdependence and strategic behaviour, analysed using game theory.
Key Terms & Definitions
Monopoly
A market structure with a single seller who faces no close competition and has significant market power.
Oligopoly
A market dominated by a few large firms, characterised by high barriers to entry, interdependence, and strategic behaviour.
Monopolistic Competition
A market with many firms selling differentiated products, low barriers to entry, and some degree of price-setting power.
Natural Monopoly
A monopoly that arises because the minimum efficient scale of production is large relative to market demand — one firm can supply the whole market at lower cost than multiple firms.
Average Revenue (AR)
Revenue per unit sold. For a monopolist, AR = Price = the demand curve.
Marginal Revenue (MR)
The additional revenue from selling one more unit. For a monopolist, MR falls faster than AR (MR curve is below and steeper than AR).
Profit Maximisation Rule
Firms maximise profit where Marginal Revenue (MR) = Marginal Cost (MC).
Price Discrimination
Charging different prices to different consumers for the same good, based on their willingness to pay.
1st Degree Price Discrimination
Charging each consumer their maximum willingness to pay — eliminates all consumer surplus. Theoretically perfect.
2nd Degree Price Discrimination
Charging different prices based on quantity consumed (e.g., bulk discounts, tiered pricing).
3rd Degree Price Discrimination
Charging different prices to different market segments (e.g., student discounts, peak/off-peak pricing).
Collusion
When oligopolistic firms cooperate to fix prices or output, acting collectively like a monopoly.
Game Theory
The study of strategic decision-making where the outcome for each participant depends on the choices of others.
Nash Equilibrium
A stable outcome in a game where no player can improve their payoff by unilaterally changing their strategy.
Prisoner's Dilemma
A game theory scenario where individually rational decisions lead to a collectively suboptimal outcome — illustrates why collusion is unstable.
IB Diagram
Accurate IB-style diagram — straight lines, labelled axes
IB Diagram
Monopoly — Profit Maximisation (HL)IB standard: straight lines · P on Y-axis · Q on X-axis · labels at end of curves · dashed drop lines to axes
Diagram Notes: Monopoly diagram: downward-sloping AR (=D) curve, MR curve below AR (twice as steep for linear demand), U-shaped AC and MC curves. Profit max at MR=MC (Qm), price read off AR curve (Pm). Shade supernormal profit rectangle. Show deadweight loss triangle vs competitive equilibrium.