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

This guide covers the monopoly statements in the market structures topic of Component 01 (Microeconomics) of the OCR A Level Economics specification, H460, Version 3.0 (June 2026), for first assessment in 2021. The specification labels no content AS or Extension, so everything here is A Level content. Each statement says “explain” or “evaluate”, and most add “with the aid of a diagram”.

Every firm, market and number below is invented for illustration. Money is in currency units (cu). Perfect competition, monopolistic competition, oligopoly, contestability and competition policy are taught in other units. Related pages: the revision notes, the practice questions, the Microeconomics overview, the exam preparation page, the OCR economics hub, the printable checklist and the free 10-minute diagnostics.

What you must be able to do

Statement	Skill
Characteristics of monopoly	Explain
Monopsony	Explain what is meant by it
Natural monopoly	Explain with a diagram, then evaluate its impact
Price maker	Explain with a diagram
Profit-maximising equilibrium	Explain price and output with a diagram
Supernormal profit, short run and long run	Explain with a diagram
Allocative and productive inefficiency	Explain with a diagram
Price discrimination	Explain with a diagram
Advantages and disadvantages of monopoly power	Evaluate with a diagram

1. Characteristics of monopoly

A pure monopoly is the only seller in a market. Real firms rarely meet that test, so economists also speak of firms with monopoly power: a large market share and the ability to set price. The characteristics are:

• One seller, or one dominant seller. The firm’s demand curve is the market demand curve, so it slopes downwards.
• High barriers to entry. Examples are economies of scale, legal protection such as patents and licences, control of a key resource, heavy sunk costs and strong branding. Barriers are what let profit last.
• No close substitutes, so demand is relatively price inelastic.
• Price making. The firm chooses its price, but must accept the quantity demanded at that price.
• Supernormal profit is possible in the long run.

2. Monopsony

A monopsony is a market with only one buyer. Where a monopoly controls the supply side, a monopsonist controls the demand side, so it can push the price it pays below the competitive level. A sole buyer of milk from many small farms is an example. In use, the word is often applied to a dominant buyer, such as a large employer in a small town, which is the labour-market case taught elsewhere in the specification. For this topic you need the definition, the contrast with monopoly and the idea that market power can sit on the buying side.

3. Price maker and profit-maximising equilibrium

A competitive firm can sell any quantity at the market price. A monopolist cannot. Selling more means cutting the price on every unit sold, so marginal revenue (MR) lies below average revenue (AR). That is why it is a price maker: it faces a falling AR curve and picks a point on it. It cannot pick a price and a quantity independently.

Worked example. A sole supplier of a patented fruit-sorting machine in Country A (illustrative) has demand P = 158 − 3Q and total cost TC = 600 + 30Q + Q².

1. TR = P × Q = 158Q − 3Q², so MR = 158 − 6Q (twice the slope of demand).
2. MC = 30 + 2Q.
3. Profit is maximised where MC = MR: 158 − 6Q = 30 + 2Q, so 8Q = 128 and Q = 16.
4. Go up to the demand curve at that output for the price (MC is a cost, not a price): P = 158 − 48 = 110.
5. TR = 110 × 16 = 1,760. TC = 600 + 480 + 256 = 1,336. ATC = 1,336 ÷ 16 = 83.5.
6. Profit = TR − TC = 1,760 − 1,336 = 424, or (110 − 83.5) × 16 = 424.

Output	Price	TR	TC	Profit
15	113	1,695	1,275	420
16	110	1,760	1,336	424
17	107	1,819	1,399	420

The table shows 16 is the best whole-unit output. Sketch (price up the side, quantity along the bottom):

Price
110 |-------*            <- price read up from Q = 16 to AR
83.5|=======|            <- ATC; shaded box = supernormal profit
 62 |.......X            <- MC cuts MR from below at Q = 16
    |       |
    +-------+----------- Quantity
            16

Downward-sloping AR (demand), MR below it with twice the slope, and an upward-sloping MC that cuts MR from below. At Q = 16, MR = MC = 62.

Price elasticity of demand (PED) at this point is (1/3) × (110/16) = 2.3, which is elastic. A monopolist never stays on the inelastic part of demand: there MR is negative, so cutting output would raise revenue and cut costs.

4. Supernormal profit in the short run and long run

Supernormal (abnormal) profit is profit above the normal profit that just keeps the owners in the market. It appears on the diagram as the rectangle between price and ATC at the profit-maximising output: (110 − 83.5) × 16 = 424.

• Short run: the monopolist makes supernormal profit whenever AR exceeds ATC at the MC = MR output. If demand were weak, AR could lie below ATC and the firm would make a loss, shutting down in the short run only if AR fell below average variable cost.
• Long run: in a competitive market, supernormal profit attracts entrants, which shifts supply right and removes the profit. A monopolist is protected by barriers to entry. No rival enters, the demand curve does not shift left, and the profit can continue. That is the key link: profit persists because of the barriers.

Evaluation: barriers are rarely absolute. Patents expire, a rival may find a substitute, and the government may regulate, so the profit lasts only as long as the barriers do.

5. Why a monopolist may be neither allocatively nor productively efficient

Allocative efficiency needs P = MC, where the value consumers place on the last unit equals its cost. Productive efficiency needs output at the minimum of the ATC curve.

Using the fruit-sorting firm:

Rule	Output	Price	ATC
Monopoly (MC = MR)	16	110	83.5
Allocative (P = MC): 158 − 3Q = 30 + 2Q	25.6	81.2	79.04
Minimum ATC (Q = √600)	24.5	n/a	78.99

• Not allocatively efficient. At Q = 16, P = 110 but MC = 62. Consumers value the last unit at far more than it costs. Output is too low, and the lost welfare is the deadweight loss triangle between demand and MC from output 16 to 25.6: 0.5 × (25.6 − 16) × (110 − 62) = 230.4.
• Not productively efficient. The firm produces at ATC 83.5, above the lowest possible 78.99. It operates on the falling part of the ATC curve, short of the lowest cost point.

“May be” matters. If a monopolist has large economies of scale, its cost curve can lie so far below a competitive industry’s that its price is lower. A regulator could also force P = MC.

6. Natural monopoly

In a natural monopoly, the long-run average cost curve is still falling when it meets market demand. A single firm then has a lower unit cost than two or more firms could manage, because fixed costs are huge and marginal cost is low. Rail track and water pipes are typical.

Worked example. A sole rail link in Country B (illustrative) has TC = 1,000 + 6Q, so MC = 6 and ATC = 1,000/Q + 6. Demand is P = 66 − 0.5Q.

Pricing rule	Condition	Output	Price	Result
Profit maximising	MR = MC: 66 − Q = 6	60	36	Profit 2,160 − 1,360 = 800
Average cost	P = ATC	100	16	Normal profit
Marginal cost	P = MC	120	6	Loss of 1,000

Check the middle row: 66 − 0.5Q = 1,000/Q + 6 gives Q² − 120Q + 2,000 = 0, so Q = 100 (or 20). At 100 units, ATC = 10 + 6 = 16.

Diagram in words: ATC slopes down throughout and stays above MC, which is flat at 6. MR cuts MC at 60 units. The unregulated price of 36 is read from demand. The ATC curve cuts demand at 100 units, and P = MC would be at 120, where price (6) is below ATC (1,000/120 + 6 = 14.3), which is why that rule makes a loss.

Duplication would waste resources: two firms each making 50 units would face ATC = 20 + 6 = 26, against 16 for one firm making 100.

Evaluating the impact of a natural monopoly

• Efficiency: scale economies lower cost per unit. This favours one firm over several.
• Consumers: unregulated, the firm restricts output to 60 and charges 36, more than double the 16 at average-cost pricing. Consumer exploitation is the main risk.
• Regulation: a price cap near average cost raises output and keeps the firm viable, but the regulator may not know the true costs. Marginal-cost pricing needs a subsidy to cover the 1,000 loss.
• Investment and quality: guaranteed profit can reduce the pressure to cut costs, but secure revenue can also fund long-lived networks.
• Judgement: the impact is positive if scale economies are large and regulation works, and negative if the firm is unregulated or the market grows enough that rivals could efficiently enter.

7. Price discrimination

Price discrimination means selling the same product to different buyers at different prices, where the gap is not explained by cost. The firm needs:

1. market power, so it can set prices;
2. a way to keep the groups apart, such as age, place or time of purchase;
3. no resale between the groups (no arbitrage);
4. different price elasticities of demand in the separate markets.

Worked example. A software firm (illustrative) has constant MC = 20. Business demand is P = 140 − 4Q and home demand is P = 88 − 4Q.

• Business: MR = 140 − 8Q = 20, so Q = 15 and P = 80. Profit = (80 − 20) × 15 = 900. PED = (1/4) × (80/15) = 1.3.
• Home: MR = 88 − 8Q = 20, so Q = 8.5 and P = 54. Profit = (54 − 20) × 8.5 = 289. PED = (1/4) × (54/8.5) = 1.6.
• Total profit with discrimination: 900 + 289 = 1,189.
• One price for both: market demand is Q = (140 − P)/4 + (88 − P)/4, so P = 114 − 2Q and MR = 114 − 4Q. Setting MR = 20 gives Q = 23.5 and P = 67, so profit = 47 × 23.5 = 1,104.5.

Discrimination adds 84.5. Business buyers have the less elastic demand, so they pay more. On a two-panel diagram, each market has its own MC = MR output, and the price is read from that market’s demand curve. The higher-priced market has the less elastic demand.

Evaluation: the firm gains revenue and may serve buyers a single price would under-serve (home buyers get 8.5 units here, against 5.25 at one price). Some buyers pay more, which is a loss of consumer surplus, and costs of policing resale are real. Whether welfare rises depends on whether total output grows.

8. Evaluating monopoly power

	Advantages	Disadvantages
Firm	Supernormal profit, secure revenue	Possible complacency and rising costs (X-inefficiency)
Consumers	Lower prices if scale economies are large; innovation	Higher price, lower output, less choice
Society	Profit funds research and development; global competitiveness	Deadweight loss; resources may be wasted defending market position

Build a chain, not a list. For example: large profits can fund research and development, which can lead to new products and lower future costs, which benefits consumers, but only if the firm chooses to reinvest and is not protected from any pressure to do so. Compare with the deadweight loss of 230.4 in section 5. Conclude with a judgement on what it depends on: the size of the cost advantage, the strength of barriers, regulation, and the time period.

Common errors

• Reading the price off the MC curve or the MR curve. Always go up to AR.
• Drawing MR with the same slope as AR. It is twice as steep for linear demand.
• Saying “monopoly is always bad”. A natural monopoly may be the lowest-cost structure.
• Shading supernormal profit between price and MC. It is between price and 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).