(HL) Market Structures and Efficiency

(HL) Perfect competition

Many small firms, an identical product, free entry and exit, perfect information. Each firm is a price taker, so $\text{AR}=\text{MR}=P$. Two efficiency results follow, and IB asks for both by name:

• Allocative efficiency — the firm produces where $P=\text{MC}$, so the value society places on the last unit equals what it cost to make.
• Productive efficiency — in long-run equilibrium the firm produces at minimum AC, so no output is wasted.

Entry and exit drive long-run profit down to normal profit: abnormal profit attracts entrants, supply rises, price falls until $P=\text{AC}=\text{MC}$ at the bottom of the AC curve.

(HL) Monopoly

One firm, high barriers to entry — legal barriers, control of a resource, brand loyalty, and above all economies of scale. The firm faces the whole market demand curve, so it is a price maker and MR lies below AR. It produces where $\text{MC}=\text{MR}$ and charges the price the demand curve allows, so $P>\text{MC}$: allocative inefficiency, measured by the deadweight loss triangle. Abnormal profit can persist because barriers keep rivals out.

Price discrimination — charging different prices to different groups for the same good — needs market power, separable groups, and different price elasticities. It converts consumer surplus into producer surplus and raises revenue; occasionally it also raises output, which is the strongest defence of it.

Natural monopoly: where LRAC falls over the whole relevant range, one firm supplying the market is cheaper than several. Splitting it up would raise unit costs, so the standard response is regulation rather than break-up.

(HL) Monopolistic competition and oligopoly

Monopolistic competition: many firms, low barriers, differentiated products. Demand is downward sloping but elastic. Abnormal profit in the short run is competed away, so the long run gives normal profit as in perfect competition, yet the firm still produces where $P>\text{MC}$ and to the left of minimum AC — excess capacity. It is neither allocatively nor productively efficient.

Oligopoly: a few large firms, measured by the concentration ratio. Its defining feature is interdependence — each firm's best move depends on what rivals do, which is why game theory is used. Firms may collude formally (a cartel) or tacitly, but the payoff structure of the prisoner's dilemma gives every member a private incentive to cheat, which is why cartels are unstable.