AQA A-level Economics: Market structures and the objectives of firms (7136) – Revision Notes

These notes boil down the AQA economics specification (AS and A-level combined, version 1.3 of 29 June 2022, first teaching September 2015) for sections 3.1.5.1 Market structures and 3.1.5.2 The objectives of firms (printed as 4.1.5.1 and 4.1.5.2 in the combined PDF). If a point is unclear, the study guide explains it in full. To test yourself, use the practice questions.

Also useful: the economics hub for AQA A-level, a checklist to print, the short diagnostics and the wider microeconomics revision notes. Every firm and number below is fictional.

Market structures: the spectrum

Perfect competition is at one end, pure monopoly at the other. Three factors place a market.

Factor	Towards perfect competition	Towards monopoly
Number of firms	Very many, each small	One, or a few large
Product differentiation	Identical products	Unique, no close substitute
Ease of entry	Free entry and exit	Barriers to entry

Structure	Firms	Product	Entry
Perfect competition	Very many	Identical	Free
Monopolistic competition	Many	Differentiated	Easy
Oligopoly	A few large	Either	Significant barriers
Pure monopoly	One	No close substitute	Blocked

Method for classifying a market

1. Count the firms and note their shares.
2. Judge how alike the products are.
3. Judge how hard entry is.
4. Name the structure and quote evidence from all three.

Key definitions

Term	Meaning
Profit	Total revenue minus total cost
Marginal revenue (MR)	Change in revenue from one more unit sold
Marginal cost (MC)	Change in cost from making one more unit
Profit-maximising rule	Produce where MC = MR, MC crossing MR from below
Divorce of ownership from control	Owners (shareholders) and decision makers (managers) are different groups
Principal-agent problem	Agents (managers) act in their own interest, not the principals’ (shareholders’)
Satisficing	Aiming for a satisfactory outcome, not the maximum
Market share	Firm’s sales divided by total market sales

Profit maximisation: method in steps

1. Find MR (change in TR) and MC (change in TC) for each unit.
2. Keep adding units while MR is at least MC.
3. Stop where the next unit has MC above MR.
4. Read the price from the demand curve (AR) at that output.
5. Profit = TR minus TC.

Diagram in words. Output on the horizontal axis, pounds on the vertical axis. MR slopes down below the demand curve, MC is U-shaped. Drop down from where MC cuts MR to find output, then go up to the demand curve for price.

Worked reminder: Firm B

Fictional Firm B has P = 96 − 4Q and TC = 40 + 16Q + Q², with Q in hundreds of units and money in thousands of pounds.

Q	P	TR	MR	TC	MC	Profit
7	68	476	44	201	29	275
8	64	512	36	232	31	280
9	60	540	28	265	33	275

The 8th unit has MR 36 above MC 31, the 9th has MR 28 below MC 33. Profit peaks at Q = 8: price £64 thousand per hundred, profit £280 thousand. Algebra check: MR = 96 − 8Q, MC = 16 + 2Q, so Q = 8.

Revenue maximisation for Firm B. Set MR = 0: 96 − 8Q = 0, so Q = 12, P = 48, TR = 576, TC = 376, profit = 200. Output is up by 4, price is down by 16, profit is down by 80.

Firm B with a profit target. Profit (in thousands of pounds) is 280 at Q = 8, 275 at Q = 7 or 9, and 260 at Q = 6 or 10. A satisficing manager with a target of 260 would accept any output from 6 to 10, so there is no pressure to find Q = 8. If the target were 275, only Q = 7, 8 or 9 would pass.

Firm B with a quality upgrade. Suppose better ingredients lift demand to P = 100 − 4Q and raise costs to TC = 40 + 30Q + Q². Then MR = 100 − 8Q and MC = 30 + 2Q, so Q = 7, P = 72, TR = 504, TC = 299 and profit = 205. Compared with the original, price is £8 thousand higher per hundred units and profit is £75 thousand lower. A quality-minded firm may accept that. A pure profit maximiser would not, unless it expects the reputation to pay back later.

Divorce of ownership from control

Reasons	Consequences
Growth needs outside capital from many shareholders	Principal-agent problem: managers know more than owners
Limited liability lets people hold shares without running the firm	Managers may favour pay, status, growth, sales or perks over profit
Large firms need specialist managers	Possible higher costs, lower profit, heavy spending on staff benefits
Many small shareholders cannot monitor managers	More takeovers or empire building; short-term or cautious decisions

Controls on managers: profit-related pay, share options, shareholder votes, takeover threat. Possible benefits: skilled professionals, longer-term planning.

How to discuss it (objectives, conduct, performance). Link each in a chain: objective (sales or growth) leads to conduct (more spending, takeovers, lower prices) and then to performance (lower profit for shareholders, higher output for customers). Then weigh it.

Other objectives

Objective	What the firm does	Likely effect
Survival	Covers costs and stays open	Low or normal profit; common in a downturn
Growth	Reinvests or expands	Lower dividends now, more power later
Quality	Spends on design, staff, service	Higher costs, higher price, loyalty
Sales revenue	Sets MR = 0	Higher output, lower price, lower profit
Market share	Prices to win customers	Lower margins now; may be a longer-term plan

Satisficing. Why: imperfect information, several stakeholders, no way to know MC and MR exactly. Effect: managers stop at an acceptable profit, so output may differ from the MC = MR output.

Must-know distinctions

• MC = MR (profit) against MR = 0 (revenue). Revenue peaks when an extra unit adds nothing to it.
• Profit maximiser against satisficer. One searches for the highest, the other stops at a target.
• Owner-managed against company with dispersed shareholders. Only the second has a strong principal-agent problem.
• Output against price. Output comes from MC = MR, price from demand at that output.
• Market share against profit. A firm can lift share and lose profit.

Quick self-test

1. Name the three factors that distinguish market structures.
2. A market has 120 sellers of identical sacks of flour and free entry. Which end of the spectrum is it nearer?
3. State the profit-maximising rule.
4. At 10 units MR is 25 and MC is 21. At 11 units MR is 19 and MC is 23. Which output maximises profit?
5. Firm C sells 18 thousand units in a market of 150 thousand. What is its market share?
6. Firm D has P = 40 − 2Q. Find the output that maximises sales revenue.
7. State two reasons for a divorce of ownership from control.
8. What is the principal-agent problem?
9. Give one way shareholders can limit it.
10. Firm E earns TR of 360 and TC of 300 at output 20, and TR of 400 and TC of 380 at output 26. Calculate the profit at each output and say which output gives the higher revenue.
11. Explain satisficing in one sentence.
12. Give one reason a firm might choose quality over profit in the short run.

Answers

1. Number of firms, degree of product differentiation, ease of entry.
2. Perfect competition (many firms, identical product, free entry).
3. Produce where MC = MR, with MC cutting MR from below.
4. 10 units, because the 11th unit has MC (23) above MR (19).
5. 18 / 150 = 0.12, which is 12.0%.
6. MR = 40 − 4Q = 0, so Q = 10 (P = 20, TR = 200).
7. Any two: firm needs capital from many shareholders; limited liability; specialist managers needed; shareholders too dispersed to monitor.
8. Managers (agents) act in their own interest, which may differ from the shareholders’ (principals’) wish for profit.
9. Profit-related pay, share options, voting at annual meetings, or takeover threat.
10. Profit is 360 − 300 = 60 at output 20 and 400 − 380 = 20 at output 26. Output 26 gives the higher revenue (400), output 20 the higher profit.
11. Aiming for a satisfactory profit and other targets, not the highest possible profit.
12. To build reputation and loyalty that raise future demand, accepting higher cost now.

Where marks are usually lost

• Naming a structure without evidence from number of firms, differentiation and entry.
• Reading price off the MC or MR curve instead of the demand curve.
• Using total figures where marginal figures are needed.
• Saying the firm “stops when profit is zero”. Profit is highest where MC = MR.
• Writing about the divorce of ownership from control without separating reasons from consequences.
• Stating the problem but not linking to objectives, conduct and performance.
• Giving a one-sided verdict where the question says discuss or evaluate.
• Mixing up satisficing with loss-making.

Official syllabus

Source: the AQA AS and A-level Economics specification (combined AS and A-level document), version 1.3, 29 June 2022. Content revised here: 3.1.5.1 and 3.1.5.2, printed as 4.1.5.1 and 4.1.5.2 in the PDF.