Pearson Edexcel International Advanced Level Economics: Monopolistic competition (YEC11) – Practice Questions

These are original questions written for Marlbridge, for revision and practice on this content. They are not reproduced past-paper questions, and they do not replicate the exam’s exact structure, question count or mark tariffs – examination boards hold copyright in their own papers. Use these alongside the official past papers from your board or school.

These questions cover monopolistic competition and contestability (3.3.3 items 4 and 8) in the Pearson Edexcel International Advanced Subsidiary/Advanced Level in Economics (YEC11) specification, Issue 2, June 2018. They sit in Unit 3, an IAL compulsory unit (full International Advanced Level only, not the IAS). All markets and figures are invented. Learn the content first in the study guide or the revision notes. See also the course hub, the checklist and the diagnostics.

Questions

1. State three assumptions of monopolistic competition. [3]

2. Classify each change by a hair salon as physical, marketing or distribution differentiation: (i) it starts home visits, (ii) it launches an organic treatment range, (iii) it redesigns its logo and bags, (iv) it adds an online booking app. [4]

3. A salon faces demand P = 50 − 0.3Q, where Q is haircuts a week and P is in currency units (cu).

(a) Calculate PED at P = 35. [2] (b) Explain how a loyalty scheme would change PED and the salon’s pricing power. [2]

4. The salon’s costs are TC = 1,000 + 10Q + 0.1Q². Demand is P = 62 − 0.3Q. Calculate the profit-maximising output, price and profit. [5]

5. New salons enter and demand becomes P = 50 − 0.3Q.

(a) Find the new output and price. [2] (b) Show that profit is normal. [1] (c) Explain why entry stops at this point. [2]

6. Demand falls instead to P = 40 − 0.3Q. Calculate output, price, ATC and the loss, and decide whether the salon should stay open in the short run. [5]

7. Using the long-run position in question 5:

(a) Show that the salon is not allocatively efficient. [2] (b) Show that it has excess capacity, given minimum ATC occurs at Q = 100. [2] (c) State one reason society may accept this outcome. [1]

8. Evaluate whether monopolistic competition is better seen as inefficient or as a source of worthwhile variety. [8]

9. (a) State two characteristics of a contestable market. [2] (b) Explain hit-and-run entry. [2]

10. In a parcel market demand is P = 40 − Q, Q is thousands of parcels and P is in cu. The incumbent’s MC is 10. An entrant must spend 216 (thousands of cu) in sunk costs, expects half the market at the incumbent’s price and plans three years.

(a) Calculate the incumbent’s monopoly price and profit. [3] (b) Show that entry is profitable at that price. [2] (c) Find the limit price. [2] (d) Calculate the incumbent’s profit at the limit price. [1]

11. The entrant in question 10 spends 400 in total but could sell assets for 100 on leaving. Calculate the new limit price and explain the change. [5]

12. Evaluate the view that contestability always benefits consumers. [8]

Answers

1. Many small firms [1]; differentiated products [1]; low barriers to entry and exit [1]. Some price-making power or imperfect information would also be accepted. [3] Examiner insight: State assumptions as separate points. Writing “many firms and differentiated products” in one phrase invites doubt about whether both ideas are present, so give each its own clause.

2. (i) Distribution [1]; (ii) physical [1]; (iii) marketing [1]; (iv) distribution [1]. [4] Examiner insight: Link the label to the specification’s own examples (shop, online, telephone for distribution; advertising and packaging for marketing). A label with no link is easy to confuse.

3. (a) dQ/dP = −1/0.3 = −3.33 [1]. At P = 35, Q = 50, so PED = −3.33 × 35/50 = −2.33 [1]. (b) Loyalty makes buyers less willing to switch, so a price rise loses fewer sales and demand is less elastic [1]. The salon can raise price with a smaller fall in sales, so its pricing power rises [1]. [4] Examiner insight: Give the sign or say “elastic” with the figure. Then interpret it: a number with no meaning for pricing leaves the analysis unfinished.

4. MR = 62 − 0.6Q and MC = 10 + 0.2Q [1]. Set equal: 52 = 0.8Q, so Q = 65 [1]. P = 62 − 0.3(65) = 42.50 [1]. TR = 2,762.50 and TC = 1,000 + 650 + 422.50 = 2,072.50 [1]. Profit = 690 cu [1]. [5] Examiner insight: Read the price from the demand curve, not from MR. Showing the MR = MC line before any arithmetic makes your method clear to the reader.

5. (a) MR = 50 − 0.6Q = 10 + 0.2Q gives Q = 50 [1] and P = 35 [1]. (b) ATC = (1,000 + 500 + 250)/50 = 35, so AR = ATC and profit is zero [1]. (c) Supernormal profit attracted entry, which cut each firm’s demand [1]. At this point there is no profit to attract more firms and no loss to drive any out [1]. [5] Examiner insight: Say that demand just touches ATC at one point. A diagram described in words should name AR, ATC, MR and MC and the equilibrium output.

6. MR = 40 − 0.6Q = 10 + 0.2Q gives Q = 37.5 [1] and P = 28.75 [1]. ATC = 1,000/37.5 + 10 + 3.75 = 40.42 [1]. Loss = (40.42 − 28.75) × 37.5 = 437.5 cu (exact ATC 40.4167) [1]. AVC = 10 + 3.75 = 13.75, below the price, so it covers variable costs and can stay open for now [1]. [5] Examiner insight: Finish with a decision, and say what is being compared. Many answers calculate a loss and stop before the shutdown judgement.

7. (a) At Q = 50, MC = 10 + 0.2(50) = 20 [1]. P = 35 exceeds MC by 15, so P ≠ MC and it is not allocatively efficient [1]. (b) Minimum ATC output is 100 and actual output is 50, so excess capacity is 50 haircuts [1]. ATC is 35 against 30 at the minimum, so it is not productively efficient [1]. (c) Consumers value the variety of salons, which a single identical product would not give [1]. [5] Examiner insight: Use both tests with figures. Saying “normal profit so efficient” confuses profit with efficiency and loses the analysis.

8. Judge using these points: (1) P > MC, so output is too low and price too high [1]; (2) excess capacity, as in question 7 [1]; (3) advertising and design raise ATC [1]; (4) against that, variety suits different tastes [1]; (5) zero long-run profit pushes firms to control costs [1]; (6) little supernormal profit for research, though firms innovate to differentiate [1]; (7) the loss is smaller where demand is flatter and the benchmark of identical products is unrealistic [1]; (8) a judgement: inefficient in the textbook sense, but the cost is modest if buyers value variety [1]. [8] Examiner insight: A balanced answer gives a reasoned conclusion that depends on something, such as how much variety is valued, rather than repeating both sides.

9. (a) Low or no barriers to entry [1]; low or no sunk costs [1]. Similar entrant costs, quick entry or good information would also be accepted. (b) An entrant enters when profit is high, takes the profit [1], then leaves before the incumbent can respond, recovering its costs [1]. [4] Examiner insight: Link hit-and-run to low sunk costs. Without that link, the explanation does not show why exit is cheap.

10. (a) MR = 40 − 2Q = 10 gives Q = 15 [1], P = 25 [1], profit = (25 − 10) × 15 = 225 [1]. (b) The entrant sells 7.5 at 25, earning 15 × 7.5 = 112.5 a year [1]. Over three years that is 337.5, above 216, so net gain is 121.5 [1]. (c) Three-year profit 1.5 × (P − 10)(40 − P) = 216, so (P − 10)(40 − P) = 144 [1]. P² − 50P + 544 = 0 gives P = 16 or 34, and the limit price is 16 [1]. (d) Q = 24, profit = 6 × 24 = 144 [1]. [8] Examiner insight: Explain why you take the lower root. A price of 34 is above the monopoly price, so it cannot be the limit price.

11. Sunk cost = 400 − 100 = 300 [1]. Then 1.5 × (P − 10)(40 − P) = 300 gives (P − 10)(40 − P) = 200 [1]. P² − 50P + 600 = 0 gives P = 20 or 30 [1], so the limit price is 20 [1]. It rises from 16 to 20 because the sunk cost is larger (300 against 216): entry risks more, so the threat is weaker and the incumbent can charge more [1]. [5] Examiner insight: Compare the two sunk costs first, then explain the direction of the change. Starting from the wrong comparison leads to a reversed explanation.

12. Benefits: price pushed towards cost [1]; incumbents kept efficient and innovative [1]; more choice [1]. Costs: cherry-picking and lost service [1]; quality or safety cut [1]; less long-term investment [1]. Judgement: depends on sunk costs [1] and whether legal barriers exist, with a clear conclusion [1]. [8] Examiner insight: “Always” invites a challenge. Name a condition under which the benefit fails, then reach a verdict.

Where marks are usually lost

• Reading price off MR instead of AR.
• Using ATC rather than MC in the MR = MC step.
• Drawing or describing long-run AR crossing ATC.
• Treating normal profit as proof of efficiency.
• Ignoring the shutdown comparison with AVC.
• Choosing the wrong root in a limit-pricing quadratic.
• Confusing sunk and fixed costs.
• Evaluation without a final judgement.

Next steps

• Revision notes
• Study guide
• Course hub and checklist
• All free 10-minute diagnostics
• Book a free trial class: trial

Official syllabus

Pearson Edexcel International Advanced Subsidiary/Advanced Level in Economics (YEC11), Specification, Issue 2, June 2018, first teaching September 2018, published by Pearson Education Limited. See sections 3.3.3 item 4 and item 8.