IB DP Economics - Unit 2 - Risks of market dominance-Study Notes - New Syllabus

Risks in Markets Dominated by One or a Few Very Large Firms (HL)

Overview

Markets dominated by one firm (monopoly) or a few large firms (oligopoly) can create several risks due to high market power. These risks mainly affect output, price, and consumer choice.

Market power → Control → Potential market failure

1. Risk in Terms of Output

Large firms may restrict output to maximize profits.

Explanation:

• Firms produce where MC = MR, not where socially optimal output occurs.
• This leads to output being lower than efficient levels.
• Some consumers who are willing to pay are unable to obtain the good.

Consequences:

• Underproduction of goods and services
• Loss of potential welfare (deadweight loss)
• Inefficient allocation of resources

Restricted output → Lost welfare

2. Risk in Terms of Price

Firms with market power can charge higher prices than in competitive markets.

Explanation:

• Price is set above marginal cost:

P > MC

• Lack of competition allows firms to increase prices.
• Consumers have limited alternatives.

Consequences:

• Higher cost of living for consumers
• Reduced consumer surplus
• Possible exploitation of consumers

3. Risk in Terms of Consumer Choice

Markets dominated by few firms often result in limited consumer choice.

Explanation:

• Fewer firms → fewer products available.
• Less competition reduces incentive to innovate or differentiate.
• Collusion may further limit variety.

Consequences:

• Reduced product variety
• Lower quality or innovation
• Consumers may not get products that best match their preferences

Economic Logic:

• Market power allows firms to act in their own interest rather than society’s.
• This leads to allocative inefficiency and welfare loss.
• These risks justify government intervention.

Key Points:

• Large firms may restrict output.
• They may charge higher prices.
• Consumer choice may be limited.
• Overall result is potential market failure.