OCR A Level Economics: Perfect competition and monopolistic competition (H460) – Revision Notes

These notes condense the full study guide for the OCR A Level Economics (H460) specification, Version 3.0 (June 2026), first assessment 2021. They cover perfect competition, monopolistic competition, and barriers to entry and exit, in Component 1, Microeconomics. The specification labels no content as AS or Extension. All figures are invented and illustrative.

Next: the practice questions, the Microeconomics revision notes, the OCR Economics hub, the printable checklist and the free diagnostics.

Key definitions

Term	Meaning
Normal profit	Minimum reward to keep the owner in the industry; TR = TC; included in AC as an opportunity cost
Supernormal profit	TR above TC
Loss	TR below TC
Price taker	A firm with no power over price; takes the market price
Allocative efficiency	P = MC
Productive efficiency	Output at the lowest point of AC
Excess capacity	Output below the output at minimum AC
Barrier to entry	Any obstacle that raises the cost or difficulty of starting up as a newcomer
Barrier to exit	Any obstacle that makes leaving the market expensive

Perfect competition at a glance

Characteristics: many buyers and sellers; identical product; perfect knowledge; free entry and exit; profit-maximising firms.

Firm diagram in words. Horizontal line at the market price, labelled P = AR = MR = demand. U-shaped MC cuts the line from below at the profit-maximising output. AC and AVC are U-shaped, with MC cutting both at their minimum points.

Market diagram in words. Downward-sloping demand and upward-sloping supply cross at the equilibrium price. A shift in supply moves the price that every firm takes.

	Short run	Long run
Price vs AC	Above (supernormal), equal, or below (loss)	Equal, at minimum AC
Profit	Supernormal, normal or loss	Normal only
Allocative efficiency (P = MC)	Yes	Yes
Productive efficiency	No, unless price is at minimum AC	Yes

Method: the firm’s decision

1. Find output where MC = MR = P (MC cutting from below).
2. Compare P with AC at that output to find profit or loss.
3. If there is a loss, compare P with AVC. If P ≥ AVC, stay open. If P < AVC, shut down.
4. In the long run, supernormal profit brings entry and a lower price. Loss brings exit and a higher price. Both end at normal profit.

Worked reminder

A price taker faces price 20 and MC = 20 at 12 units, with AC of 17 at that output. TR = 20 × 12 = 240, TC = 17 × 12 = 204, profit = 36. If AC were 23, TC = 276 and the result is a loss of 36. Whether to stay open then depends on AVC: if it is below 20, the firm continues.

Why the loss-making firm may stay open

Fixed costs are paid whether or not the firm produces. If P ≥ AVC, each unit covers its variable cost and gives something towards fixed cost, so the loss from producing is smaller than the loss from closing. In the long run all costs are variable, so a firm that cannot reach AC will leave.

Usefulness of perfect competition: evaluation chain

• For: benchmark for efficiency; shows how entry erodes supernormal profit; helps explain price-taking in standardised-goods markets.
• Against: unrealistic assumptions; large MES may rule out many small firms; normal-only profit may limit funds for innovation; allocative efficiency is private only if externalities exist.
• Judgement: better as a yardstick than as a description. Say what the answer depends on, such as the market and the question asked.

Monopolistic competition at a glance

Characteristics: many firms; differentiated products; downward-sloping, fairly elastic demand; low barriers to entry and exit; non-price competition; independent decisions.

Firm diagram in words. Downward-sloping AR (demand), with MR below it. MC cuts MR from below at the profit-maximising output. Read price up to the AR curve at that output.

	Short run	Long run
Demand	Position and elasticity set by rivals	Shifts left and becomes more elastic after entry (right for survivors after exit)
Profit	Supernormal or loss	Normal; AR just touches AC (tangency)
P vs MC	P > MC	P > MC
Efficiency	Neither allocative nor productive	Neither: excess capacity

Worked reminder

A firm has MC = MR at 6 units, reads a price of 15 from its demand curve, and has AC of 12 at 6 units. Profit = (15 − 12) × 6 = 18. In the long run, entry shifts demand left until price equals AC at the new output, so profit is zero.

Advantages and disadvantages

Advantages	Disadvantages
Choice and variety	P > MC: allocative inefficiency
Competition keeps profit near normal	Excess capacity; AC above the minimum
Low barriers let new firms in	Advertising and differentiation costs
Incentive to improve quality	Differences may be superficial

Evaluation points: the inefficiency is smaller when demand is very elastic; consumers may value variety more than the lost efficiency; it depends on whether differentiation is real.

Barriers to entry and exit

Entry	Exit
Economies of scale	Sunk costs
High start-up capital	Specialised, hard-to-sell assets
Patents and licences	Redundancy and contract costs
Brand loyalty and advertising	Long-term supplier contracts
Control of inputs or distribution	Reputation damage

Perfect competition: none. Monopolistic competition: low. A barrier to exit can keep a loss-making firm open longer, which slows adjustment.

Reasoning chains to learn

Entry in perfect competition. Supernormal profit signals that the industry is attractive. New firms enter because there are no barriers. Market supply shifts right. The market price falls, so every firm’s horizontal demand line moves down. Entry stops when price equals minimum AC and profit is normal.

Entry in monopolistic competition. Supernormal profit attracts firms whose products are close substitutes. Each existing firm loses customers, so its demand curve shifts left. More substitutes also make demand more elastic, so the curve becomes flatter. Entry stops when demand just touches AC, where profit is normal. The touching point is to the left of the lowest point of AC, which gives excess capacity.

Exit after a fall in demand. Price falls below AC and firms make losses. Firms leave once they can, and barriers to exit slow this. Supply shifts left in perfect competition, or the demand curve for each survivor shifts right in monopolistic competition, until normal profit returns.

Where the two structures differ

	Perfect competition	Monopolistic competition
Product	Identical	Differentiated
Demand facing the firm	Horizontal	Downward-sloping
Price power	None	Some
MR vs price	Equal	MR below price
Barriers	None	Low
Long-run P vs MC	Equal	P above MC

Must-know distinctions

• Normal vs supernormal profit: normal is TR = TC; supernormal is TR above TC.
• Shut-down vs break-even: shut down when P < AVC; break even when P = AC.
• Allocative vs productive efficiency: P = MC versus lowest AC.
• Price taker vs price maker: perfectly elastic demand versus downward-sloping demand.
• Short run vs long run: fixed factors exist in the short run only, and entry and exit happen in the long run.

Quick self-test

1. A price taker sells 50 units at 8 each, with TC of 420. State its profit or loss.
2. What are the AR and MR of a perfectly competitive firm?
3. At the long-run price, market demand is 500 units and each firm produces 10. How many firms are there?
4. Which efficiency does P = MC show?
5. Why does a perfectly competitive firm achieve productive efficiency only in the long run?
6. State the PED of the demand curve facing a perfectly competitive firm.
7. State the short-run shut-down rule.
8. A monopolistically competitive firm sells 10 units at 12 each, with AC of 9. Calculate its profit.
9. A firm has demand P = 20 − q. Find MR at 6 units, and TR.
10. Why does entry shift a monopolistically competitive firm’s demand curve left?
11. Define excess capacity.
12. Give two barriers to exit.

Answers

1. TR = 8 × 50 = 400; profit = 400 − 420 = loss of 20.
2. Both equal the market price.
3. 500 ÷ 10 = 50 firms.
4. Allocative efficiency.
5. Only in the long run does entry drive price down to the minimum of AC, so output is at the lowest point of AC. In the short run, price can be above AC.
6. Infinite (perfectly elastic).
7. Stay open if price is at least AVC; shut down if price is below AVC.
8. (12 − 9) × 10 = 30.
9. P = 20 − q gives MR = 20 − 2q, so MR = 20 − 12 = 8; TR = (20 − 6) × 6 = 84.
10. Entrants take customers, so each existing firm sells less at every price.
11. Producing below the output at which AC is lowest.
12. Any two of: sunk costs, specialised assets, redundancy costs, long-term contracts.

Where marks are usually lost

• A downward-sloping demand curve drawn for a perfectly competitive firm.
• Profit shown without comparing price with AC at the output chosen.
• Writing “supernormal profit is made because price is high” with no mention of AC.
• Shut-down judged by loss rather than by price against AVC.
• Treating efficiency as a yes-or-no label with no link to P = MC or minimum AC.
• Claiming the monopolistically competitive firm makes supernormal profit in the long run.
• Describing entry without saying what happens to price or demand next.
• An evaluation that lists strengths and limits but gives no judgement.
• Listing barriers without saying how each one blocks entry or exit.

Official syllabus

OCR, A Level in Economics (H460) specification, Version 3.0 (June 2026), first assessment 2021, Component 1 Microeconomics, topic on market structures.