OCR A Level Economics: Monopoly, natural monopoly and price discrimination (H460) – Revision Notes

These notes condense the monopoly statements in the market structures topic of Component 01 (Microeconomics) in OCR A Level Economics, H460, Version 3.0 (June 2026), for first assessment in 2021. Read the study guide for the full explanations. Test yourself with the practice questions. Other links: the Microeconomics revision notes, the OCR economics hub, the printable checklist and the free 10-minute diagnostics.

All firms and numbers are invented for illustration. Money is in currency units (cu).

Definitions

Term	Meaning
Monopoly	One seller (pure monopoly), or a firm with a dominant share and the power to set price
Monopsony	One buyer, or a dominant buyer, able to push the price it pays down
Price maker	A firm whose downward-sloping demand lets it choose the price
Supernormal (abnormal) profit	Profit above normal profit, shown by the gap between AR and ATC
Natural monopoly	An industry in which average cost is still falling at the size of the whole market, so a single firm is cheapest
Price discrimination	Different prices for the same product, not explained by cost differences
Allocative efficiency	P = MC
Productive efficiency	Output at minimum ATC

Characteristics of monopoly

• Single or dominant seller; the firm’s demand is the market demand.
• High barriers to entry: economies of scale, patents and licences, control of a resource, sunk costs, branding.
• No close substitutes.
• Price maker: sets price, accepts the quantity demanded.
• Supernormal profit can last in the long run.

Method: profit-maximising equilibrium

1. Write TR = P × Q. Find MR (for straight-line demand, MR has the same intercept and twice the slope).
2. Find MC.
3. Set MC = MR and solve for Q.
4. Read the price from the demand (AR) curve at that Q.
5. Find ATC at that Q and compute profit = (P − ATC) × Q.

Worked reminder. A sole supplier of specialist tiles (illustrative) has demand P = 100 − 2Q and TC = 400 + 10Q + 0.5Q², so MC = 10 + Q.

• MR = 100 − 4Q. MR = MC: 100 − 4Q = 10 + Q, so Q = 18.
• P = 100 − 36 = 64.
• TR = 1,152. TC = 400 + 180 + 162 = 742. Profit = 410. ATC = 41.2.

Benchmark	Q	P	ATC
Monopoly (MC = MR)	18	64	41.2
Allocative (P = MC): 100 − 2Q = 10 + Q	30	40	38.3
Minimum ATC (Q = √800)	28.3	n/a	38.28

• Deadweight loss = 0.5 × (30 − 18) × (64 − 28) = 216 (MC at 18 is 28).
• The firm is allocatively inefficient (P = 64 against MC = 28) and productively inefficient (ATC 41.2 against a minimum of 38.28).

Diagram checklist (draw it every time)

• Axes labelled: price/costs and quantity.
• AR (demand) sloping down; MR below it, steeper.
• MC upward sloping, cutting MR from below; mark the output.
• Go up from that output to AR for the price. Go down to ATC for the cost per unit.
• Shade the rectangle between price and ATC: supernormal profit.
• Where asked about efficiency: mark the P = MC output further right, and the minimum ATC point.

Price
 64 |------*             price from AR
41.2|======|             shaded: supernormal profit
 28 |......X             MC = MR at Q = 18
    +------+------ Quantity
          18

Supernormal profit: short run and long run

• Short run: profit exists whenever AR is above ATC at the MC = MR output. A loss occurs if AR is below ATC there.
• Long run: barriers stop entry, so no new supply shifts demand left. The barriers are the reason the profit persists.
• Limit: barriers can erode (patent expiry, substitutes, regulation).

Monopsony in brief

• One buyer (or a dominant buyer) facing many sellers.
• It can pay less than a competitive market would, because sellers have few other places to sell.
• Typical settings: a sole buyer of farm produce, or a major employer in a small town. The labour-market version is taught in the labour market topic, not here.
• Link to monopoly: both are market power. Monopoly is power over the price charged; monopsony is power over the price paid.

Natural monopoly

Worked reminder. A sole irrigation network (illustrative) has TC = 300 + 4Q, so MC = 4 and ATC = 300/Q + 4. Demand is P = 36 − 0.2Q.

Rule	Output	Price	Result
MR = MC: 36 − 0.4Q = 4	80	20	Profit 1,600 − 620 = 980
P = ATC: 0.2Q² − 32Q + 300 = 0	150	6	Normal profit (ATC = 2 + 4 = 6)
P = MC	160	4	Loss of 300 (the fixed cost)

• Diagram: ATC falling throughout and above MC; MR = MC gives the unregulated output; the P = ATC point lies to its right.
• Impact: lowest-cost structure and no wasteful duplication, but a risk of high price and low output if unregulated. Regulation (a price cap) needs cost information. P = MC needs a subsidy.
• Evaluation words: depends on size of scale economies, quality of regulation, whether the market is large enough to support rivals.

Price discrimination

Conditions: market power; separable markets; no resale; different elasticities.

Worked reminder. A hillside attraction (illustrative) has constant MC = 6. Tourist demand is P = 50 − 2Q. Local demand is P = 26 − Q.

Market	MR = MC	Q	P	PED	Profit
Tourists	50 − 4Q = 6	11	28	1.27	242
Locals	26 − 2Q = 6	10	16	1.6	100

• Total profit with discrimination = 342.
• One price: Q = 51 − 1.5P, so P = 34 − Q/1.5 and MR = 34 − 2Q/1.5. MR = 6 gives Q = 21, P = 20, profit = 14 × 21 = 294.
• Gain from discrimination = 48. Tourists (less elastic) pay more; locals pay less.
• Gains: more profit, some buyers served who would be priced out. Losses: some consumer surplus lost; policing costs.

Evaluating monopoly power

For	Against
Economies of scale can cut price	Higher price and lower output than competition
Profit can fund research and development	Allocative and productive inefficiency; deadweight loss
Can compete internationally	X-inefficiency and complacency
Natural monopolies avoid duplication	Consumer exploitation if unregulated

Judgement phrases: it depends on the size of the cost advantage; on whether profit is reinvested; on barriers and regulation; on the time period.

Chains of reasoning to rehearse

Why is a monopolist a price maker? Demand is the market demand and slopes down, so there is a different price for each output; the firm picks the point on that curve; entry is blocked, so rivals cannot undercut it.

Why is output below the allocatively efficient level? MC = MR gives Q = 18 where P = 64 is well above MC = 28; consumers value extra units at more than they cost; output stops short; the triangle between AR and MC (216) is lost welfare.

Is a natural monopoly good or bad? Falling ATC means one firm is cheapest; duplication would raise cost per unit; but with no regulation the price is 20 instead of 6; so the answer depends on regulation, and on how well the regulator knows costs.

Does price discrimination help consumers? Locals pay 16 instead of 20, and 6 locals become 10 locals served; tourists pay 28 instead of 20; so one group gains and another loses, and the overall result depends on how much extra output is produced.

Must-know distinctions

• Monopoly (seller) versus monopsony (buyer).
• Pure monopoly versus monopoly power.
• Allocative (P = MC) versus productive (minimum ATC).
• Supernormal profit rectangle (price to ATC) versus deadweight loss triangle (between AR and MC).
• Profit-maximising output (MC = MR) versus allocatively efficient output (P = MC).

Quick self-test

1. State two characteristics of monopoly.
2. Demand is P = 40 − Q. Write the MR function.
3. A monopolist has TR = 500 and TC = 420. Find profit.
4. Demand is P = 50 − 2Q. Find MR at 10 units.
5. What is a monopsony?
6. Why can supernormal profit last in the long run under monopoly?
7. State the condition for allocative efficiency.
8. A firm has TC = 100 + 2Q. Find ATC at 25 and at 50 units. What does this suggest?
9. Name two conditions needed for price discrimination.
10. Price is 30, ATC is 22, output is 12. Find supernormal profit.

Answers

1. Any two: one or dominant seller, high barriers, price maker, no close substitutes.
2. MR = 40 − 2Q.
3. 500 − 420 = 80.
4. MR = 50 − 4Q = 50 − 40 = 10.
5. A market with a single (or dominant) buyer, able to push down the price it pays.
6. High barriers to entry stop new firms competing away the profit.
7. P = MC.
8. ATC at 25 = 150 ÷ 25 = 6; at 50 = 200 ÷ 50 = 4. Falling ATC points to a natural monopoly.
9. Any two: market power, separable markets, no resale, different elasticities.
10. (30 − 22) × 12 = 96.

Where marks are usually lost

• Quoting an MC or MR value as the price instead of reading AR.
• Drawing MR parallel to AR instead of steeper.
• Shading supernormal profit between price and MC.
• Calling every monopolist inefficient with no “may be” and no mention of scale economies.
• Explaining that profit persists without naming barriers to entry.
• Describing price discrimination without a condition such as no resale.
• Listing advantages and disadvantages with no judgement or no “it depends on”.
• Treating a natural monopoly as an ordinary monopoly and ignoring its falling ATC.

Official syllabus

OCR A Level in Economics (H460), Version 3.0 (June 2026), for first assessment in 2021, published by OCR (Oxford Cambridge and RSA Examinations).