AQA A-level Economics: Monopoly, monopoly power and price discrimination (7136)

This guide follows the AQA AS and A-level Economics specification (version 1.3, 29 June 2022) for the A-level, first taught from September 2015. It covers two sub-sections of Perfect competition, imperfectly competitive markets and monopoly, numbered 3.1.5 on the AQA website (the combined PDF prints the A-level version as 4.1.5): Monopoly and monopoly power, and Price discrimination. The specification gives no AS-only or A-level-only labels for this content. Every number below is invented for illustration and describes no real firm or country.

Read it with the revision notes and the practice questions. For the wider unit, see the overview of individuals, firms, markets and market failure, the AQA A-level Economics hub and the printable checklist. To find weak spots first, use the free 10-minute diagnostics.

What this unit covers

Sub-section	What you must be able to do
Monopoly and monopoly power	Use the formal diagram of the monopoly model; explain how barriers to entry, the number of competitors, advertising and product differentiation influence monopoly power; weigh the advantages and disadvantages of monopoly; explain why firms in monopolistically competitive and oligopolistic markets are price makers with varying degrees of monopoly power
Price discrimination	State the conditions necessary; weigh advantages and disadvantages; give real-world examples; assess the impact on producers and consumers; analyse it with diagrams

How oligopolists react to each other, how markets are contested over time, and a full efficiency and surplus comparison are taught on separate pages. Here the focus is the price-making firm itself.

The monopoly model

A pure monopoly is the sole seller in a market. It faces the whole market demand curve, so that curve is its average revenue (AR) curve and slopes downward. To sell more, the monopolist must lower the price on all units, so marginal revenue (MR) lies below AR. For a straight-line demand curve, MR starts at the same point on the price axis and is twice as steep.

Total revenue rises while MR is positive and peaks where MR is zero. At that point price elasticity of demand is exactly 1. A profit-maximiser never sells where MR is negative, because revenue would fall while costs rose. So it operates on the elastic part of demand.

Method for the diagram:

1. Find the output where MR = MC.
2. Go up to the AR curve to read the price.
3. Compare price with average cost (AC) at that output. If price is above AC, the rectangle (price − AC) × output is supernormal profit.

Worked example 1: a patented water filter (illustrative)

Demand is P = 60 − 2Q, so MR = 60 − 4Q. Marginal cost is a constant £12 and fixed costs are £96.

Q	P (£)	TR (£)	MR between rows (£)	TC (£)	Profit (£)
6	48	288		168	120
8	44	352	32	192	160
10	40	400	24	216	184
12	36	432	16	240	192
14	32	448	8	264	184
16	28	448	0	288	160

• MR = MC: 60 − 4Q = 12, so Q = 12. Price from AR: P = 60 − 24 = £36.
• AC at 12 units = (96 + 12 × 12) / 12 = £20. Profit per unit = £16, so supernormal profit = 16 × 12 = £192. The table agrees.
• Elasticity at this point: the slope of demand gives ΔQ/ΔP = −1/2, so PED = −(1/2) × (36/12) = −1.5. Demand is elastic, as it must be where MR is positive.
• The gap between price and marginal cost is £24. A firm facing perfect competition would have price equal to MC, which here is £12 at 24 units. The monopolist sells half that output at three times the price.

Read the diagram in words: output (12) sits where the MR curve crosses the flat MC curve; price (£36) sits directly above on the AR curve; the supernormal profit rectangle lies between £36 and £20 over 12 units.

Factors influencing monopoly power

Monopoly power is the ability to set price above marginal cost without losing so many customers that profit falls. It is a matter of degree. The specification lists four of these influences.

• Barriers to entry. Legal barriers (patents, licences), economies of scale that make a large firm’s costs far lower than an entrant’s, high sunk costs, control of key inputs and strong brands all stop rivals entering. The higher the barriers, the longer supernormal profit lasts.
• The number of competitors. Fewer rivals, or a larger market share, means customers have fewer places to go. Demand for the firm’s product becomes less price elastic.
• Advertising. It builds loyalty and makes the firm’s demand less elastic. Because it is a large, unrecoverable cost, heavy advertising can also act as a barrier to entry.
• Product differentiation. The more unique the product appears, the fewer close substitutes and the steeper the firm’s demand curve.

All four work through the same mechanism: they make demand for the firm’s product less elastic and entry harder.

Price making in monopolistic competition and oligopoly

Firms in monopolistically competitive and oligopolistic markets are price makers. Their products are differentiated, so each faces a downward-sloping demand curve and chooses price by setting MR = MC, as a monopolist does. What differs is the degree of monopoly power.

Worked example 2: two price makers (illustrative)

Both firms have MC = £10. Firm A sells a distinctive product: P = 50 − 2Q, so MR = 50 − 4Q. Firm B sells in a crowded market: P = 30 − Q, so MR = 30 − 2Q.

	Firm A	Firm B
MR = MC	50 − 4Q = 10, Q = 10	30 − 2Q = 10, Q = 10
Price	£30	£20
Mark-up over MC	£20 (66.7% of price)	£10 (50% of price)
PED at that point	(1/2)(30/10) = 1.5	(1)(20/10) = 2.0

Both are price makers, but Firm B’s more elastic demand gives it a smaller mark-up. Close substitutes (many rivals in monopolistic competition) or the reactions of a few large rivals (oligopoly) limit how far a firm can raise price. Neither is a price taker, and neither has the unchallenged power of a pure monopolist.

Advantages and disadvantages of monopoly

Disadvantages

• Higher price and lower output than a competitive market with the same costs, as in example 1.
• Price above marginal cost: the output between 12 and 24 units, which consumers value above its cost, is not produced (allocative inefficiency).
• Weak pressure to cut costs, so costs may be higher than necessary (X-inefficiency).
• Supernormal profit transferred from consumers to owners, which may widen inequality.
• Less choice and possibly lower quality or slower improvement.

Advantages

• Economies of scale: one large firm may produce at much lower cost.
• Dynamic efficiency: supernormal profit can fund research and investment, and the prospect of it rewards invention.
• Natural monopoly: where one firm’s average cost falls across the whole market, duplication would waste resources.
• Possible international competitiveness through scale.

Worked example 3: can a monopoly beat competition on price?

Market demand is P = 60 − 2Q. A competitive industry has constant MC of £40, so P = MC gives Q = 10 and P = £40. Suppose one firm takes over, keeps the £40 cost, and prices as a monopolist: 60 − 4Q = 40, so Q = 5 and P = £50. Consumers lose.

Now suppose economies of scale cut its MC to £16: 60 − 4Q = 16, so Q = 11 and P = £38. Price is £2 lower and output one unit higher than under competition. Profit is (38 − 16) × 11 = £242 before fixed costs.

The break-even cost saving: the monopoly price is (60 + MC)/2, which equals £40 when MC = £20. Anything above £20 leaves consumers worse off.

Evaluation: the verdict depends on the size of the cost saving, whether the profit is reinvested, how contestable the market is, and whether regulation limits price. Do not claim that monopoly is always bad or always good.

Price discrimination

Price discrimination is charging different prices to different customers for the same good or service, where the difference is not explained by differences in cost. Real-world examples include peak and off-peak rail fares, student discounts, and airline fares that change with booking date.

Conditions necessary

1. Price-setting power: the firm must be a price maker.
2. Separable markets: it must be able to identify and divide customers into groups (by age, time, location or income).
3. Different price elasticities of demand in the groups, so there is a profit to be made from charging them differently.
4. No resale: customers who pay the low price must not be able to sell to those who would pay the high price.

Worked example 4: an indoor climbing centre, two markets (illustrative)

MC = £6 per session ticket, with no fixed costs. Peak-time customers: P = 46 − Q₁. Off-peak customers: P = 30 − Q₂. The firm sets MR = MC in each market, so total output is shared out where marginal revenue is equal in both.

	Peak	Off-peak
MR	46 − 2Q₁	30 − 2Q₂
MR = 6	Q₁ = 20	Q₂ = 12
Price	£26	£18
PED at that point	26/20 = 1.3	18/12 = 1.5
Profit	20 × £20 = £400	12 × £12 = £144

Total profit with discrimination = £544. Price is higher where demand is less elastic.

Single price for comparison. Adding the demands for prices up to £30 gives Q = 76 − 2P, so P = 38 − Q/2 and MR = 38 − Q. MR = 6 gives Q = 32 and P = £22. Peak buys 24 and off-peak buys 8. Profit = 16 × 32 = £512. (Charging only peak-time customers £26 gives £400, which is worse.)

Effects.

• Producer: profit rises by £32.
• Peak customers pay £4 (18.2%) more and buy fewer tickets (20 instead of 24).
• Off-peak customers pay £4 (18.2%) less and buy more (12 instead of 8).
• Total output is unchanged at 32 here; with other demand curves it can rise.
• Consumer surplus falls from £320 to £272 (peak £288 to £200, off-peak £32 to £72).

Perfect price discrimination

If the firm knew each customer’s maximum willingness to pay, it could charge each exactly that. Using example 1 (P = 60 − 2Q, MC = £12), output expands to where price equals MC, 24 units. Revenue is the area under demand: (60 + 12)/2 × 24 = £864. Cost is 12 × 24 = £288. Profit is £576 (before fixed costs), against £288 for the single-price monopolist. Consumer surplus is zero, but output is as high as under competition.

Advantages and disadvantages

• For producers: higher profit, which can fund investment; spare capacity (empty off-peak seats) is filled.
• For some consumers: lower prices, and access for low-income groups or to services that could not cover costs at one price.
• Against consumers: higher prices for the less elastic group; consumer surplus transferred to the firm; fairness concerns.
• Against efficiency: the cost of identifying groups and stopping resale; output may fall if the low-price market is not served.

Evaluation: a gain for one group is a loss for another, so judge by who loses, whether output rises, and how profit is used.

Common errors

• Drawing MR above AR, or reading price off the MR curve instead of AR.
• Saying a monopolist charges the highest possible price. It charges the profit-maximising price.
• Listing barriers to entry without saying how they protect profit.
• Calling monopolistic competitors “price takers”.
• Forgetting the no-resale condition for price discrimination.
• Claiming price discrimination always raises output or always harms consumers.

Official syllabus

AQA AS and A-level Economics specification (7135 and 7136), version 1.3, 29 June 2022, published by AQA, for exams from June 2016 onwards. Sections used: Monopoly and monopoly power, and Price discrimination.