Pearson Edexcel International Advanced Level Economics: Monopoly and monopsony (YEC11) – Revision Notes

These notes condense section 3.3.3 Market structures and contestability, items 6 (Monopoly, a to h) and 7 (Monopsony, a and b), of the Pearson Edexcel International Advanced Subsidiary/Advanced Level in Economics specification (YEC11), Issue 2, June 2018. The specification labels Unit 3 as an IAL compulsory unit (IA2 content, not part of IAS). Full explanations are in the study guide. Test yourself with the practice questions, check the Edexcel economics hub, tick off the printable checklist, and find gaps with the free 10-minute diagnostics. All figures are invented.

Definitions

Term	Meaning
Monopoly (6a)	Single seller, no close substitutes, high barriers to entry, price maker
Barrier to entry (6b)	Anything that stops or deters new firms: scale economies, patents and licences, branding, sunk costs, limit pricing
Barrier to exit	Cost of leaving: sunk costs, redundancy pay, contracts
Natural monopoly (6e)	Long-run average cost falls over the whole market, so one firm is cheapest
Third-degree price discrimination (6f)	Different prices to different groups for the same product, not based on cost
Monopsony (7a)	Single or dominant buyer, so a price or wage maker
Marginal cost of labour	Extra labour cost of hiring one more worker, above the wage under monopsony

Key rules and formulas

Idea	Rule
Profit maximum	MR = MC, with MC cutting MR from below
Price	Read up to the demand (AR) curve
Straight-line demand P = a − bQ	MR = a − 2bQ
Supernormal profit	(P − ATC) × Q
Deadweight loss	Triangle between demand and MC, from monopoly output to the P = MC output
Price discrimination	MR = MC in each market, so the less elastic market pays more
Natural monopoly pricing	MR = MC (profit), P = ATC (normal profit), P = MC (efficient, but a loss)
Monopsony	MCL = MRP gives employment; read the wage from the supply curve

Method: monopoly equilibrium

1. Write demand as P = a − bQ and find MR = a − 2bQ.
2. Find MC from the cost function.
3. Solve MR = MC for Q.
4. Substitute Q into demand for P.
5. Find ATC at Q, then profit = (P − ATC) × Q.

Reminder (cement producer): P = 120 − 4Q, MC = 24 + 4Q gives Q = 8, P = 88, ATC = 70, profit 144. The P = MC benchmark gives Q = 12 and P = 72. The deadweight loss is ½ × 4 × 32 = 64.

Efficiency under monopoly (6h)

Type	Verdict	Reason
Allocative	Fails	P exceeds MC, so output is too low
Productive	Usually fails	Output is not at minimum ATC
Dynamic	Arguable	Profit funds R&D, but weak competition reduces pressure to innovate

Costs and benefits of monopoly (6d)

• Firms gain: supernormal profit, reinvestment funds, economies of scale, lower risk.
• Firms lose: regulation, fines, possible X-inefficiency.
• Consumers gain: lower prices if scale economies are large, innovation, compatibility.
• Consumers lose: higher price, lower output, less choice.
• Evaluate with: size of the cost advantage, regulation, whether profit is reinvested, and how high barriers really are.

Natural monopoly (6e)

• Cause: large fixed costs and low marginal cost.
• Duplication raises cost: one firm making 30 units with fixed cost 90 and MC 3 has ATC 6; two firms making 15 each have ATC 9.
• Regulation options: price cap near average cost, subsidy for marginal cost pricing, or franchise bidding.
• Weakness: the regulator lacks cost information.

Third-degree price discrimination (6f, 6g)

Conditions. Price-making power; separable markets; no resale between groups; different elasticities of demand.

Method. Find MR = MC separately in each market, then read each price from that market’s demand curve.

Reminder (ferry). MC = 12. Adults P = 100 − 2Q give Q = 22, P = 56. Students P = 60 − 2Q give Q = 12, P = 36. Profit is 1,256 against 1,156 with one price (P = 46, Q = 34). Consumer surplus falls from 778 to 628.

Evaluation.

• Firms: higher profit.
• Consumers: low-elasticity group worse off, high-elasticity group better off.
• Welfare rises if a market is opened that a single price would exclude, and may fall if it only moves surplus to the firm.

Monopsony (7a, 7b)

Assumptions and conditions. One or a dominant buyer; many sellers; upward-sloping supply; immobile workers; few alternative employers; weak unions.

Reminder. Supply W = 6 + 0.5L, MRP = 30 − 0.5L, so MCL = 6 + L.

	Competitive	Monopsony
Workers	24	16
Wage	18	14

A minimum wage between 14 and 22 raises employment above 16 here, because it flattens the supply curve the firm faces. Above 22, employment falls below 16.

Costs and benefits.

• Firms: lower costs; but turnover, low morale, hard-to-fill posts.
• Consumers: lower prices if savings are passed on; risk to quality or supplier survival.
• Employees: lower wage and fewer jobs than competition; some jobs may exist only because of the employer.

Worked reminder: opening a new market

Adults: P = 100 − 2Q with MC = 12 gives Q = 22 and P = 56. Suppose a second group has demand P = 30 − 2Q.

1. A single price of 56 is above 30, so the second group buys nothing.
2. Discriminating, MR = 30 − 4Q = 12 gives Q = 4.5 and P = 21.
3. Extra profit = 4.5 × (21 − 12) = 40.5. Extra consumer surplus = ½ × 4.5 × 9 = 20.25.
4. Total surplus rises by 60.75, with nobody made worse off.

The chain to write: group excluded at the single price, so discrimination serves it, so output and welfare rise.

Evaluation chains to learn

• Monopoly and consumers: high barriers, so little rivalry, so higher price and lower output. Against this, scale economies lower cost, so price could fall if savings are passed on. Judge by the size of the saving and the strength of regulation.
• Natural monopoly: falling LRAC, so one firm is cheapest, so competition duplicates fixed cost. Unregulated, the firm sets MR = MC and restricts output. Regulation helps only if the regulator has good cost information.
• Price discrimination: the low-elasticity group pays more and the high-elasticity group pays less. Total effect on consumers depends on whether new buyers are served.
• Monopsony: MCL above the wage, so the firm hires fewer workers at a lower wage. A minimum wage within a range lifts both wage and employment. Above that range it cuts employment.

Must-know distinctions

• Monopoly (one seller) and monopsony (one buyer).
• Price from the demand curve, wage from the supply curve.
• Natural monopoly (cost-driven, falling LRAC) and legal monopoly (patent or licence).
• Productive efficiency (minimum ATC) and allocative efficiency (P = MC).
• Pricing to maximise profit and pricing to give normal profit.

Quick self-test

1. Define monopsony.
2. A monopolist faces P = 50 − Q with MC = 10. Find output and price.
3. Demand is P = 200 − 5Q. Find MR at Q = 8.
4. State the four conditions for third-degree price discrimination.
5. Market X has PED 1.2 and market Y has PED 0.6. Which pays the higher price, and why?
6. A natural monopoly has fixed cost 90 and MC 3. Compare ATC for one firm making 30 with two firms making 15 each.
7. Labour supply is W = 2 + 0.1L. Find MCL at L = 20.
8. With that supply, MRP = 14 − 0.1L. Find monopsony employment and wage, and the competitive outcome.
9. Demand P = 60 − 2Q, MC = 20. Find the deadweight loss of monopoly.
10. Give one argument for and one against monopoly being dynamically efficient.

Answers

1. A market with a single (or dominant) buyer, which is a price or wage maker.
2. MR = 50 − 2Q = 10, so Q = 20 and P = 30.
3. MR = 200 − 10Q = 120.
4. Price-making power; separable markets; no resale; different elasticities.
5. Y, because less elastic demand means a higher price still maximises profit.
6. One firm: (90 + 90)/30 = 6. Two firms: (90 + 45)/15 = 9. One firm is cheaper.
7. TC = 2L + 0.1L², so MCL = 2 + 0.2L = 6 (wage 4).
8. 2 + 0.2L = 14 − 0.1L gives L = 40, wage 6 (MRP 10). Competitive: 2 + 0.1L = 14 − 0.1L gives L = 60, wage 8.
9. Monopoly: 60 − 4Q = 20 gives Q = 10, P = 40. Competitive Q = 20. DWL = ½ × 10 × (40 − 20) = 100.
10. For: supernormal profit funds R&D. Against: little competitive pressure to innovate.

Where marks are usually lost

• Reading the price off the MC or MR curve rather than demand.
• Giving MR a different intercept from a straight-line demand curve.
• Describing barriers without saying why each blocks entry.
• Using price discrimination conditions without separation or no-resale.
• Writing “consumers lose” with no reason such as a higher price or lower output.
• Reading the monopsony wage from MCL.
• Treating productive and allocative efficiency as the same.
• Stopping at description with no judgement, for example no mention of the scale of cost savings or regulation.

Examiner insight: answers tend to gain credit when each claim is followed by a reason and a context link, and tend to lose it when evaluation is a list of “it depends” statements with no stated factor.

Official syllabus

Source: Pearson Education Limited, Edexcel International Advanced Subsidiary/Advanced Level in Economics (specification, Issue 2, June 2018; first teaching September 2018), section 3.3.3 Market structures and contestability, items 6 and 7.