Economics (Year 11) - Market Failure
When companies hold a large percentage of an industry, a large portion of market share as well as maintain a substantial profit, they are known to have lots of market power. Furthermore, natural monopolies and oligopolies are extreme examples of companies with large market power. Market Power is an example of market failure as they generate lower levels of economic welfare than markets with perfect competition.
Explanation and Model
As shown by the model above, the influences companies with large shares of market power have over price levels, can drastically decrease consumer surplus. This means that market failure occurs, as deadweight loss is created.
The red supply line of the uncompetitive market shows that the goods sold are price inelastic. This means that when the price of the good increases, the quantity demanded only reduces slightly. For instance, petrol is a price inelastic good, as, despite the price, consumers need petrol in order to travel. This means that petrol and oil companies have a large share of market power.
The model shows the difference in economic welfare in a non-competitive market (black) and in a competitive market (red). In a competitive market with no influences from market power, consumer surplus is shown by areas A+B+C+F. Producer surplus is shown by areas D+E+G.
However, in a non-competitive market, with degrees of market power present, consumer surplus decreases to areas A. This means that deadweight loss occurs as a result of decreased welfare. This is shown by areas F+G. The area of producer surplus is shown by areas B+C+D+E.
(TIP: This type of model that is labelled into segments is a common exam feature as it allows students to demonstrate their understanding of economic graphs. Also, this method may be helpful to create in extended responses in order to help discuss your arguments in a clear and logical format.)