IB DP Economics: Market power (HL) – Revision Notes

These revision notes condense sub-topic 2.11, market failure – market power, from the IB Diploma Programme Economics guide (first assessment 2022, published February 2020), the course examined from the 2022 session onwards. All of 2.11 is HL only. For full explanations read the market power study guide, then try the market power practice questions. Course pages: the IB DP Economics hub and the printable checklist. All numbers below are invented.

Key definitions

Term	Meaning
Market power	A firm’s ability to influence the price it charges
Price taker	Firm with no market power; takes the market price
Price maker	Firm with some market power; chooses price along its demand curve
AR	TR/Q, which equals price; the demand curve
MR	Change in TR from one more unit
AC, MC	TC/Q; change in TC from one more unit
Abnormal profit	AR > AC
Normal profit	AR = AC
Loss	AR < AC
Allocative efficiency	P = MC (MB = MC); community surplus at its maximum
Welfare loss	Surplus lost because output is below the allocatively efficient level
Natural monopoly	One firm supplies the market at lowest cost because scale economies are so large
Concentration ratio	Combined market share of the largest n firms

Market structures at a glance

	Perfect competition	Monopoly	Oligopoly	Monopolistic competition
Firms	Many	One or dominant	Few, large	Many
Entry	Free	High barriers	High barriers	Free
Product	Homogeneous	No close substitutes	Often differentiated	Differentiated
Demand facing firm	Horizontal	Downward, least elastic	Downward	Downward, more elastic than monopoly
Price taker or maker	Taker	Maker	Maker	Maker
Long-run profit	Normal	Can stay abnormal	Can stay abnormal	Normal

Method: profit from data (calculation, HL only)

1. Compute TR = P × Q for each quantity.
2. MR = change in TR. MC = change in TC.
3. Find the last unit where MR is at least MC. That is the profit-maximising Q.
4. Read price (AR) at that Q. Compute AC = TC/Q.
5. Profit = TR - TC, or (AR - AC) × Q. Classify: AR > AC, AR = AC, AR < AC.

Reminder. Firm with P = 60 - 5Q and TC = 84 at Q = 4 (TC = 72 at Q = 3): TR = 160, MR = 160 - 135 = 25, MC = 84 - 72 = 12. Profit = 160 - 84 = 76. AC = 21 and AR = 40, so abnormal.

Perfect competition

• P = D = AR = MR, a horizontal line at the market price.
• Short run: produce where MC = MR (so MC = P). Draw AC above, level with or below the price line to show loss, normal profit or abnormal profit.
• Long run: abnormal profit draws entry, supply shifts right, price falls. Losses cause exit, supply shifts left, price rises. Stops at normal profit.
• Worked check: TC = 100 + 4Q + Q². At P = 40, Q = 18 and profit = 720 - 496 = 224. At P = 24, Q = 10 and TR = TC = 240. At P = 16, Q = 6 and loss = 160 - 96 = 64.
• Equilibrium diagram: demand and supply (MB and MC) cross at the market price. At that point P = MC, so allocative efficiency and maximum community surplus.

Monopoly

Steps for the diagram:

1. Draw downward AR and the steeper MR below it (MR cuts the quantity axis halfway to where AR does, for a straight line).
2. Draw MC rising and AC U-shaped.
3. Find MC = MR and drop to the quantity axis.
4. Go up to AR for the price, and across to AC for the cost per unit.
5. Shade the rectangle between AR and AC: abnormal profit. If AC touches AR, normal profit. If AC is above AR, loss.

Comparison with perfect competition (same MC as supply):

	Perfect competition	Monopoly
Rule	P = MC	MC = MR, price from AR
Example output	21	14
Example price	54	68
Efficiency	Allocatively efficient	Allocatively inefficient

The welfare loss triangle lies between demand and MC, from the monopoly quantity to the competitive quantity. In the example, ½ × 7 × 28 = 98.

Natural monopoly diagram. AC falls across all market demand, with MC below AC. Unregulated output is at MC = MR, with high price. Efficient P = MC gives a loss because MC is below AC. A compromise regulated price is P = AC, normal profit, more output.

Quick numbers: demand P = 40 - Q, MC = 4, fixed cost 180. Unregulated Q = 18, P = 22, profit 144. P = MC gives a loss of 180. P = AC gives Q = 30, P = 10.

Oligopoly

• Few large firms, high barriers, interdependence: each firm must predict rivals’ reactions.
• Collusive: firms agree price or output. A collusive oligopoly acts like a monopoly: industry output where industry MC = MR, price from industry demand.
• Non-collusive: firms compete. Risk of a price war. Oligopoly is allocatively inefficient (P > MC), a market failure.
• Incentive to collude: higher joint profit. Incentive to cheat: a firm that secretly undercuts gains at its rivals’ expense.
• Price competition: price cuts. Non-price competition: advertising, branding, quality, service, loyalty.
• Concentration ratio: add the largest n shares. Shares 26, 21, 17, 13, 9, 8, 6 give CR3 = 64 and CR4 = 77.

Payoff matrix reading rule: for each of your rival’s choices, find your better choice. If it is the same whichever choice they make, expect you to play it.

	B High	B Low
A High	40, 40	15, 55
A Low	55, 15	25, 25

Both choose Low, getting 25 each. Collusion at High gives 40 each, but each has an incentive to cheat for 55.

Monopolistic competition

• Many firms, free entry, differentiation. Demand is more elastic than a monopolist’s because of close substitutes.
• Short run: MC = MR, can earn abnormal profit, like a monopoly.
• Long run: entry shifts each firm’s demand left until AR is tangent to AC, giving normal profit. Exit after losses does the reverse.
• Allocatively inefficient (P > MC), but less than monopoly, and more product variety.
• Example: long-run AR = 30 - Q, MC = 10, AC = 100/Q + 10. Q = 10, P = 20 = AC, MR = 30 - 20 = 10 = MC.

Large firms and policy

Advantages	Risks	Government responses
Economies of scale, including natural monopoly	Lower output, higher price	Legislation and regulation
Abnormal profit can fund R&D and innovation	Reduced consumer choice	Government ownership
	Abuse of power	Fines

For evaluation: effect on consumers against firms, short run against long run, how much information the regulator has, and whether the market is contestable.

Where 2.11 is examined

Because 2.11 is a topic studied at HL only, it can appear in the HL papers and not in the SL ones.

Paper (HL)	Length	Format	Weighting
Paper 1	1 hour 15 minutes	Extended response: one question from three, 25 marks	20%
Paper 2	1 hour 45 minutes	Data response: one question from two, 40 marks, some quantitative	30%
Paper 3	1 hour 45 minutes	Policy paper: two compulsory questions, 30 marks each, quantitative and qualitative	30%

Command terms to expect on this content: Calculate asks for the stages of working, Draw asks for a labelled, accurate diagram, Explain asks for reasons or causes, and Evaluate asks you to weigh strengths against limitations. Advice: if a question gives a table of data, state MC = MR explicitly, then show the numbers on either side of it.

Two more worked reminders

Normal profit check. A firm sells 6 units at price 9 with TC = 54. TR = 54, so TR - TC = 0 and AC = 9 = AR. That is normal profit, not a loss.

Welfare loss check. Demand P = 80 - 2Q and MC = 20 + 2Q. Competitive output: 80 - 2Q = 20 + 2Q gives Q = 15. Monopoly output: MR = 80 - 4Q = 20 + 2Q gives Q = 10, P = 60, MC = 40. Welfare loss = ½ × (15 - 10) × (60 - 40) = 50.

Quick self-test

1. State the demand curve facing a perfectly competitive firm.
2. A firm sells 8 units at price 20 with TC = 140. Calculate profit and say if it is abnormal, normal or a loss.
3. TR rises from 90 to 110 when output goes from 4 to 5. State MR of the fifth unit.
4. State the output rule for profit maximisation.
5. Why does a monopolist cause a welfare loss relative to perfect competition?
6. Market shares are 40, 30, 20 and 10 per cent. Calculate CR2.
7. A firm in monopolistic competition earns abnormal profit. Outline what happens next.
8. Give one advantage and one risk of a dominant firm.
9. Name the three government responses in the guide to abuse of market power.
10. At output 12, a monopolist has MR = 15, MC = 15, AR = 30, AC = 22. Calculate profit.

Answers

1. Horizontal at the market price (P = D = AR = MR).
2. TR = 160, profit = 160 - 140 = 20. AC = 17.5 < AR = 20, so abnormal profit.
3. MR = 110 - 90 = 20.
4. Produce where MC = MR.
5. It restricts output and sets price above MC, so units valued above marginal cost go unproduced.
6. 40 + 30 = 70 per cent.
7. Entry occurs, demand shifts left and becomes more elastic, and profit falls to normal.
8. Advantage: economies of scale, or profit to fund R&D. Risk: higher price and lower output, or less choice.
9. Legislation and regulation, government ownership, and fines.
10. (30 - 22) × 12 = 96.

Where marks are usually lost

• Naming the right rule but not showing the stages. Calculate asks for the working.
• Reading the price from MR or MC instead of AR.
• Calling any profit “normal”.
• Shading the welfare loss as a rectangle, or drawing it with MR.
• Leaving axes, curves and equilibrium points unlabelled on diagrams.
• Asserting oligopolies always collude. Show the incentive to cheat.
• Describing government intervention with no judgement of its limits.
• Treating a concentration ratio as a measure of profit.

Next steps

Work through the practice questions, find gaps with the diagnostics, and review the study guide.

Official syllabus

IB Diploma Programme Economics guide, first assessment 2022, published by the International Baccalaureate Organization (February 2020), sub-topic 2.11.