1.5 Perfect competition, imperfectly competitive markets, and monopoly

Question 1

Price taker

Answer 1

a firm which accepts the ruling market price set by market conditions

Question 2

Price maker

Answer 2

a firm possessing the power to set the price within the market

Question 3

Characteristics of perfect competition (6)

Answer 3

• a large number of buyers and sellers
• all buyers and sellers possesses perfect market information
• buyers/sellers can buy/sell as much as they wish at the market price
• any single buyer or seller is unable to influence the market price
• the goods being sold are homogeneous
• no barriers to entry or exit

Question 4

Homogeneous goods

Answer 4

goods which are identical

Question 5

Barriers to entry

Answer 5

factors that prevent or discourage new firms from entering a market, helping existing firms maintain market power.

these can be:

structural - economies of scale, high fixed costs

strategic - limit pricing

legal & regulatory - licensing, patents, trade restrictions and tariffs ( prevent international comp)

Question 6

Consumer surplus

Answer 6

the difference between the amount the consumer is willing to pay for a product and the price they have actually paid

The area between the horizontal equilibrium price line and the demand curve represents the consumer surplus in the market (ABPe)

The consumer surplus lies underneath the demand curve

Question 7

Producer surplus

Answer 7

the difference between the amount that the producer is willing to sell a product for and the price they actually receive

The area between the horizontal equilibrium price line and the supply curve represents the producer surplus in the market (CBPe)

Producer surplus lies above the supply curve

Question 8

Deadweight loss

Answer 8

Deadweight loss is the loss of economic efficiency that occurs when the allocative optimum (where MSB = MSC) is not achieved, leading to a reduction in total welfare.

Question 9

Allocative efficiency

Answer 9

when resources are allocated in a way that maximizes societal welfare, meaning:

Marginal Social Benefit (MSB) = Marginal Social Cost (MSC)

or P=MC

Question 10

SR perfect competition

Answer 10

• firms can be making abnormal profit
• new firms cannot enter the market due to there being at least one fixed factor of production
  Existing firms can adjust variable inputs (e.g., hire more workers), but cannot instantly expand capacity.

New firms cannot enter because they need time to acquire/build fixed assets.

Question 11

Describe perfect competition in the long run

Answer 11

• new firms enter the market
  new firms can enter by building factories, buying machines, etc.
• the equilibrium price in the market falls, just until firms are making normal profit

Question 12

Monopoly power

Answer 12

the ability of a firm to influence or control the price and output of a good or service in the market power to set prices and other aspects of the market such as differentiation. Firms in market structures other than perfect competition possess a degree of monopoly power

1. Control over product design & features
   A monopolist doesn’t face strong rivals, so they can decide what features or qualities the product has.

They may innovate, change the style, add premium features, or use branding to make the product stand out — even if there’s no real functional difference.

🛍 Example: A tech firm with monopoly power might release a new phone with slightly upgraded cameras and market it as revolutionary.

Question 13

Monopoly

draw the graph

Answer 13

a market structure with only firm in the market

total costs under supernormal prof

MC cuts AC at the lowest point

Question 14

Natural monopoly

Answer 14

when there is only room in a market for one firm benefiting from economies of scale to the fullest

Question 15

Differentiated goods

Answer 15

goods which are different from other goods

Question 16

Market failure

Answer 16

when the market mechanism leads to a misallocation of resources in an economy, either completely failing to provide a good or service or providing the wrong quantity

P does not = MC

Question 17

Oligopoly + graph

Answer 17

a market structure where there are a small number of interdependent firms

Top 3-5 firms control ≥60-70% of the market

if costs changes in the vertical gap a profit maximizing oligopolist will always charge price p1

Question 18

Collusion def + pros(producers) & cons(consumers+ 1producer con)

Answer 18

agreements between firms to restrict competition

PROS (advantages for firms):

-Higher Profits
Firms act like a monopoly, reducing output and raising prices (P > MC).
Example: OPEC oil cartel limits supply to boost prices.

-Price Stability Reduced Uncertainty
Avoids price wars
Firms can coordinate production without fear of being undercut.

-Cost Savings
No need for aggressive advertising or R&D spending if competition is suppressed.

CONS :(Disadvantages for Economy & Consumers)

Higher Prices & Allocative Inefficiency
Consumers pay more → deadweight loss (MSB > MSC).

Unstable Agreements
Incentive to cheat (e.g., one firm undercuts others secretly → prisoner’s dilemma).

Reduced Consumer Choice
reduce comp less innovation and invention

Risk of Detection & Penalties
Illegal in most countries UK Competition and Markets Authority fines

Incentive to cheat
one firm undercuts others secretly → prisoner’s dilemma

Question 19

How does monopoly power lead to market failure? (4 point analysis)

Answer 19

Monopoly power can lead to market failure because monopolists can restrict output and raise prices above the competitive level.
✅ (1 mark - Identification of market failure caused by monopoly power)

This results in allocative inefficiency, as price exceeds marginal cost (P > MC), meaning resources are not being used to maximise consumer welfare.
✅ (1 mark - Explanation using economic concept of allocative inefficiency)

Additionally, consumers face higher prices and less choice, leading to a loss of consumer surplus and a deadweight loss to society.
✅ (1 mark - Application of impact on consumers and welfare loss)

Therefore, monopoly power causes a misallocation of resources and reduces overall economic welfare.
✅ (1 mark - Analytical conclusion linking back to market failure)- redistributes welfare away from consumers to producers

Question 20

Barriers to entry in a monopoly (7)

Answer 20

• patents
• limit pricing
• brand loyalty
• control over outlets
• control over suppliers
• legislation
• cost-advantage economies of scale

Question 21

Legislation

Answer 21

government may restrict the ability of firms to compete in the market. e.g. for 350 years Royal Mail was the only firm allowed to deliver letters in the UK

Question 22

Ways to differentiate a product (4)

Answer 22

• improved product
• nicer packaging
• compatibility with complements
• production methods

Question 23

Brand loyalty

Answer 23

when consumers repeat purchase from the same firm, instead of swapping and switching between firms. It can be expensive for new firms to develop a brand image to break existing loyalties within the market

Question 24

Control over outlets

Answer 24

if a firm controls the place where a product is sold it means their competitors may not be able to sell their products

Question 25

Patents and trademarks

Answer 25

legal protection which prevents other firms from imitating existing ideas

Question 26

Control over suppliers

Answer 26

if a firm controls the materials needed to make a good it means potential new firms may not be able to produce their goods

Question 27

Cost advantage

Answer 27

firm has achieved a lower average cost because of the economies of scale, potential competitors may not be able to compete as they cannot produce as cheaply

Question 28

Reaction of existing firms

Answer 28

new firms may not enter a market if they think it will trigger a price war

Question 29

Limit pricing

Answer 29

prices set low enough to make it unprofitable for new firms to enter a market

Question 30

Divorce of ownership from control

Answer 30

the owners and those who manage the firm are different groups with different objectives

Question 31

Principle-Agent Problem

Answer 31

When the agent (worker or manager) doesn't act in the best interest of the principle (owner).

Question 32

solutions to principal-agent problem (2)

Answer 32

give shares How it works: Ties agent rewards to firm performance Evaluation: ✅ Encourages effort. ❌ May encourage short-term risk-taking Long-term employment contracts with clawback clauses. How it works: Penalises poor performance (e.g., fired for missing targets). Evaluation: ✅ Aligns long-term goals. ❌ fear of penalties may create excessive pressure, reducing morale or encouraging short-termism—where employees focus on hitting short-term targets at the expense of sustainable performance.

Question 33

Revenue maximisation occurs at

Answer 33

MR = 0

Question 34

Profit maximisation occurs at

Answer 34

MC = MR

Question 35

Sales maximisation

Answer 35

occurs when revenue is maximised (while still generating normal profit); AR=ATC or ac

Question 36

Market share maximisation

Answer 36

occurs when a firm maximises its percentage share of the market in which it sells its product

Question 37

Economic surplus maximisation

Answer 37

- occurs where a firm maximises the size of the consumer and producer surplus, achieving allocative efficiency - occurs where MC=AR

Question 38

Survival

Answer 38

occurs where a firm avoids making or reduces the size of subnormal profit, or potential subnormal profit

Question 39

Quality maximisation

Answer 39

occurs where a firm maximises the quality of the goods that they are selling

Question 40

Growth maximisation

Answer 40

The objective of increasing the size of the firm : no. of employees market share

Question 41

Stakeholders

Answer 41

People with an interest in an organisation

Question 42

Shareholders

Answer 42

owners of shares in a company

Question 43

Satisficing

Answer 43

achieving a satisfactory outcome rather than the best possible outcome

Question 44

Profit satisficing

Answer 44

Making enough profit to satisfy the needs of the firm's owner(s)

Question 45

Productively efficient

Answer 45

the level of output at which average costs are minimised mc= ac

Question 46

X-inefficiency

Answer 46

X-inefficiency occurs when a firm fails to minimise its production costs due to a lack of competitive pressure, resulting in higher average costs

Question 47

Dynamic efficiency

Answer 47

Dynamic efficiency occurs when firms improve quality, innovation which usually comes from supernormal profit , and production techniques over time, leading to: Lower long-run average costs (LRAC) Better products/services Sustained economic growth

Question 48

Concentration ratio

Answer 48

the total market share of leading firms in a market, or the output of these firms as a percentage of total market output Real-World Example (AQA Context) UK Grocery Market (2023): Tesco (27%), Sainsbury’s (15%), Asda (14%), Morrisons (10%) → CR4 = 66% (Oligopoly).

Question 49

Advantages of monopoly (3)

Answer 49

Economies of Scale Lower LRAC: Diagram: Downward-sloping LRAC curve. I Supernormal profits --> dynamic efficiency Stable Prices -->Avoids price wars

Question 50

Disadvantages of monopoly (4)

Answer 50

-Allocative Inefficiency Monopolies set P > MC (profit-maximising at MR=MC). Effect: Higher prices Lower output leading to deadweight loss consumer exploitation -X-Inefficiency No pressure to minimise costs due to Lack of competition → waste (e.g., overstaffing). -Reduced Consumer Choice Single supplier → less variety -Regressive Impact Higher Prices Disproportionately harms low-income households (e.g., energy bills).

Question 51

Market share formula

Answer 51

Firm's sales/Total Market Sales X 100

Question 52

Cartel

Answer 52

a group of firms who collude with each other

Question 53

Price fixing

Answer 53

agreeing prices with your competitors, or agreeing to offer discounts at the same time, or agreeing to raise prices at the same time

Question 54

Market sharing

Answer 54

dividing a market (e.g. by region or customer type), and agreeing not to sell to each other's customers

Question 55

Consumer inertia

Answer 55

the tendency of consumers to buy or continue buying a good, even when superior options exist

Question 56

Price war

Answer 56

occurs when rival firms continuously lower prices to undercut each other with the aim to gain or defend market share

Question 57

Impact of sub-normal profit under perfect competition

Answer 57

- sub-normal profit in the short run means firms leave the market - price then returns to equilibrium in long run

Question 58

impact of supernormal profit under perfect competition

Answer 58

- supernormal profit in the short run attracts firms to the market - price and quantity then return to equilibrium in long run

Question 59

impact of perfect competition on economic welfare

Answer 59

- leads to allocative efficiency - maximum possible mutually beneficial transactions take place - absence of deadweight loss

Question 60

How is productive efficiency shown on a cost/revenue diagram?

Answer 60

AC minimised (where MC=AC) or atc

Question 61

How is allocative efficiency shown on a cost/revenue diagram?

Answer 61

P=MC

Question 62

resource misallocation

Answer 62

when resources are allocated in a way which does not maximise economic welfare P doesn't =MC MSC does not = MSB

Question 63

Conditions of monopoly (5)

Answer 63

- only one firm in the market - there may be imperfect information - the firm is a price setter - the goods in the market are differentiated - there are barriers into the market

Question 64

Shutdown point

Answer 64

the level of output (in the short-run) where a firm has no economic benefit of producing; occurs where AR=AVC

Question 65

shutdown price

Answer 65

the minimum price a firm needs to charge to justify remaining in the market in the short run

Question 66

Characteristics of monopolistic competition (6)

Answer 66

-many buyers and sellers -product differentiation -some monopoly power -low barriers to entry an exit -non price competition -sr supernormal prof lr normal prof

Question 67

How efficient is monopolistic competition?

Answer 67

neither productively nor allocatively efficient in the long run and short run

Question 68

short-run impacts of abnormal profits under monopolistic competition

Answer 68

- new firms attracted to market - however they cannot enter in short run due to fixed costs Short-run fixed costs/barriers: Even though barriers to entry are low in monopolistic competition, there are still practical delays. These include market research, product development, and setting up supply chains.

Question 69

Long-run impacts of abnormal profits under monopolistic competition

Answer 69

- incumbent firms cannot maintain abnormal profit due to new firms entering the market because of the absence of barriers to entry, and goods being partially substitutable

Question 70

interdependence

Answer 70

in market theory, when the actions of one firm will have an impact on other firms in the market

Question 71

Game theory and conclusions

Answer 71

prisoners dilemma for oligopoly price rigidity (bottom right) cause non price comp tempted to collude (top left) incentive to cheat on collusion ( bottom left, top right)

Question 72

Nash equilibrium

Answer 72

a situation where no player can improve their position given the choice of the other players bottom right

Question 73

The Competition and Markets Authority (CMA)

Answer 73

government agency responsible for advising on and implementing UK competition policy

Question 74

Resale Price Maintenance (RPM)

Answer 74

imposing minimum prices on distributors such as shops

Question 75

Predatory pricing

Answer 75

cutting prices below cost in order to force a smaller or weaker competition out of the market

Question 76

Tacit collusion

Answer 76

where firms collude without any formal agreement and where there has been no explicit communication between firms about market conduct strategy

Question 77

Bounded rationality

Answer 77

an individual's rationality is limited by the information they have

Question 78

Creative destruction

Answer 78

a process where firms produce or create innovative goods that replace or destroy existing goods in the market

Question 79

Internal economies of scale

Answer 79

long-run average costs falling caused by growth of the firm

Question 80

Advantages of oligopoly (4)

Answer 80

1 Innovation & Dynamic Efficiency (3.4.2) R&D Investment: Supernormal profits fund innovation (e.g., Apple vs. Samsung smartphone competition). AQA Example: Pharmaceutical oligopolies develop life-saving drugs. 2 Consumer Choice & Quality Non-price competition (e.g., branding, features) increases variety (e.g., car models). 3 Price Stability (Kinked Demand Curve – 3.6.5) Avoids destructive price wars, protecting jobs and firm survival. 4 Economies of Scale (3.6.2) Lower Costs: Large firms benefit from bulk buying and specialisation (e.g., Tesco’s distribution networks). AQA Link: Drives down LRAC, allowing lower consumer prices.

Question 81

Disadvantages of oligopoly (4)

Answer 81

1. Collusion & Cartels Higher Prices & Allocative Inefficiency illegal for CMA Uk 2. Predatory pricing (e.g., Amazon undercutting small retailers). 3. Non-Price Competition Waste Excessive advertising (e.g., Coca-Cola vs. Pepsi) raises costs without improving quality. 4. Price Stickiness (Kinked Demand Curve) Firms delay price cuts in recessions → prolongs economic downturns. In a recession, demand falls. Firms don’t lower prices because rivals would match → no gain in customers, just lower profits. Instead, they delay price cuts or try non-price competition (e.g., better service, ads). This slows the economy’s adjustment, prolonging the recession (because prices stay too high, output and employment stay low).

Question 82

Describe the shape of the AR curve under oligopoly

Answer 82

- kinked - more price elastic at a lower level of output than the kink - more price inelastic at a higher level of output

Question 83

Price discrimination

Answer 83

charging different prices to different customers for the same product or service, with the price based on different willingness to pay

Question 84

First-degree price discrimination

Answer 84

where a firm charges each customer for each unit the maximum price which the customer is willing to pay for that unit

Question 85

First-degree price discrimination example (1)

Answer 85

- a market stall trader not putting any prices on the wares, instead choosing to haaggle

Question 86

Second-degree price discrimination

Answer 86

where a firm charges a consumer so much for the first so many units purchased, a different price for the next so many unit purchased, and so on

Question 87

Second-degree price discrimination examples (3)

Answer 87

- electricity is more expensive for the first number of units - after 10 minutes calls become cheaper - loyalty cards reward frequent buyers with discounts on future products

Question 88

Third-degree price discrimination

Answer 88

where a firm divides consumers into different groups and charges a different price to consumers in different groups, but the same price for all consumers within a group

Question 89

Third-degree price discrimination examples (4)

Answer 89

- student discounts - happy hours in pubs - zip card

Question 90

Effects of price discrimination that directly benefit consumers (4)

Answer 90

- some consumers will benefit from lower prices and products that might not otherwise be supplied - may increase total sales and generate economies of scale, perhaps lowering prices - allows firms to cross-subsidise loss-making services

Question 91

Effects of price discrimination that DO NOT directly benefit consumers

Answer 91

- some consumers will face a higher price due to asymmetric information this allows the producer to convert consumer surplus into producer surplus evaluation -may benefit producer by allowing producers to reduce fixed costs by spreading demand

Question 92

Conditions required to price discriminate (3)

Answer 92

- firm must have some monopoly power - it must be possible to identify different groups of customers for the good. - markets must be separated to prevent seepage

Question 93

Contestable market

Answer 93

a market in which the potential exists for new firms to enter the market. A perfectly contestable market has no entry or exit barriers and no sunk costs, and both incumbent firms, and new entrants have access to the same level of technology

Question 94

Conditions of contestable markets

Answer 94

- absence on entry barriers - absence of exit barriers (sunk costs) - consumers don't have total brand loyalty to already existing firms within the market

Question 95

Sunk costs

Answer 95

costs that have already been incurred and cannot be recovered

Question 96

Break even

Answer 96

- sales is maximised while still generating normal profit - AKA sales maximisation - AC = AR

Question 97

Free Market Forces

Answer 97

Question 98

SR perfect competition

Answer 98

industry - firm

Question 99

Subnormal profit

Answer 99

AC>AR

Question 100

LR perfect competition

Answer 100

Question 101

requirements for monopolistic competition

Answer 101

Question 102

SR monopolistic competition

Answer 102

Question 103

LR monopolistic competition

Answer 103

new firms enter the market D shifts to the left as consumers are spread across more firms so demand for the individual firm ( which the diagram is for) will decrease . until AR = AC (normal profit is made) AC curve touches AR curve bottom of AC curve touches MC COMPARE TO PERFECT COMP AND MONOPOLY FOR EVALUATION

Question 104

Efficiencies for perfect, monopoly, and monopolistic competition

Answer 104

PERFECT: allocative + productive but no dynamic MONOPOLY: Dynamic MONOPOLISTIC: none in theory but may have more dynamic efficiency than perfect comp may be more productively efficient than perfect comp may be more dynamic than monopoly closer to allocative efficiency than monopoly

Question 105

Pareto efficiency

Answer 105

A situation where no one can be made better off without making someone else worse off. ✅ Used in welfare economics → represents optimal resource allocation.

Question 106

static efficiency

Answer 106

Efficiency at a specific point in time, combining allocative + productive efficiency.

Question 107

objectives of firms

Answer 107

prof max mc = mr rev max mr= 0 sales max ar=ac growth max (market share , size - employees outlets) Corporate Social Responsibility (CSR) → Some firms pursue ethical/environmental goals → e.g. reducing emissions, fair trade, sustainability. Survival → Especially relevant in recession or new businesses (SR)