OxfordAQA International AS and A-level Economics: Competitive market structures (9640)

This guide follows the OxfordAQA International AS and A-level Economics specification (9640), version 1.2. It covers sections 3.3.3.1 (market structures), 3.3.3.2 (perfect competition) and 3.3.3.3 (monopolistic competition). Section 3.3 is the extra International A2 content, examined in Unit 3. Quantitative skills (3.5) may appear in any unit, so the calculations use QS4 (graphs), QS6 (cost, revenue and profit, with marginal values for A2), QS8 (elasticity) and QS9. Every name and figure is invented.

Oligopoly, monopoly power and competition policy are separate statements taught elsewhere. Use the revision notes for recall and the practice questions to test yourself. Related: market structures and firms’ objectives, the course hub and checklist. Unsure where you stand? Try a free 10-minute diagnostic.

What you must be able to do

Section	What it asks for
3.3.3.1	The spectrum from perfect competition to pure monopoly; how number of firms, product differentiation and ease of entry separate structures
3.3.3.2	Characteristics of perfect competition; short-run and long-run diagrams; price takers; the efficiency proposition and its assumptions, assessed critically; perfect competition as a yardstick in product and labour markets
3.3.3.3	Characteristics of monopolistic competition; short-run and long-run diagrams; non-price competition, which strengthens monopoly power but can also make markets more competitive and benefit consumers

3.3.3.1 Market structures

Market structures lie on a spectrum. Perfect competition is one end and pure monopoly is the other. Real markets sit between them, so say “closest to”.

Three features place a market on the spectrum: the number of firms, the degree of product differentiation and the ease of entry.

Structure	Firms	Product	Entry	Control over price
Perfect competition	Huge number	Same from every seller	Free	None (price taker)
Monopolistic competition	Large number	Differentiated	Easy	Some
Oligopoly	A few dominant	Same or differentiated	Hard	Considerable, with rivals in mind
Pure monopoly	A single seller	No close substitute	Blocked	Greatest

To place a case-study market, test each feature in turn. Many growers selling identical onions is close to perfect competition. Forty independent cafes, each with its own menu and location, is close to monopolistic competition.

3.3.3.2 Perfect competition

Characteristics

• A large number of buyers and sellers; none can move the price alone.
• Homogeneous (identical) products.
• Free entry and exit.
• Perfect knowledge of prices and technology.
• Firms are price takers: they accept the market price set by industry demand and supply.

The firm can sell as much as it likes at the going price, so its demand curve is horizontal and AR = MR = price. A rise above the market price loses every customer, and a cut gains nothing.

Short-run decision rule

A profit-maximising firm produces where MC = MR, with MC rising. Here MR = price, so the rule is MC = P. With a table of discrete units, produce each unit whose MC is no more than the price.

Worked example (Farm F, invented). Fixed cost is 40 a week. Output is in crates of eggs.

Crates	TVC	MC	AVC	TC	AC
1	30	30	30.00	70	70.00
2	52	22	26.00	92	46.00
3	70	18	23.33	110	36.67
4	90	20	22.50	130	32.50
5	115	25	23.00	155	31.00
6	148	33	24.67	188	31.33
7	190	42	27.14	230	32.86

• Price 40. MC of the sixth crate is 33 (at most 40) and of the seventh is 42 (above 40), so produce 6. TR = 6 × 40 = 240. TC = 188. Profit = 52, which is supernormal.
• Price 31. Produce 5 (MC of the sixth is 33). TR = 155 = TC, so profit is zero: normal profit. Price equals minimum AC.
• Price 28. Produce 5. TR = 140, TC = 155, so a loss of 15. Price is above AVC (23), so sales cover variable cost and contribute 5 × 5 = 25 towards fixed cost. The loss is smaller than the fixed cost of 40, so the farm stays open.
• Price 21. Producing 4 gives TR = 84 against TC = 130, a loss of 46. Closing costs only the fixed cost, 40. Price is below minimum AVC (22.50), so the farm shuts down.

Shutdown rule: in the short run, continue to produce while price is at least AVC. In the long run, a firm must cover all its costs, so it leaves if price stays below AC.

The diagram in words

Draw two panels. In the market panel, industry demand slopes down and industry supply slopes up, meeting at the market price. In the firm panel, a horizontal line at that price is AR = MR, with U-shaped AC and rising MC, and MC cuts AC at its minimum. The firm produces where MC meets the price line.

Price above AC at that output gives supernormal profit, shown as a rectangle between price and AC. Price equal to minimum AC touches the AC curve at its lowest point. Price below AC but above AVC is a loss, yet the firm stays open.

Long-run adjustment

Supernormal profit attracts entry. Market supply shifts right, price falls, and each firm’s horizontal line moves down until profit is normal. Where firms make losses, some leave, supply falls and price rises until the losses stop.

Worked example. Market demand is Qd = 1,000 − 10P. With 100 farms each producing 6 crates, supply is 600 and the price is 40, since 1,000 − 400 = 600. Each farm makes 52, so firms enter.

• Long-run price = minimum AC = 31. Market quantity = 1,000 − 310 = 690.
• Each farm produces 5 crates, so the number of farms is 690 ÷ 5 = 138, which means 38 entrants.
• Price has fallen by 22.5% (40 to 31) and total output has risen by 15%.

Now start from 138 farms and let demand fall to Qd = 970 − 10P. At a price of 28, demand is 690, equal to 138 × 5, so 28 is the short-run price. Each farm loses 15, so some leave. At price 31 demand is 660, so the long-run number is 660 ÷ 5 = 132: six farms exit.

Efficiency: the proposition

Perfect competition is said to give an efficient allocation of resources when its assumptions hold, including the absence of externalities.

• Allocative efficiency: P = MC. The price buyers pay reflects what the last unit is worth to them, and MC what it costs to make.
• Productive efficiency: long-run output is at minimum AC, so no resources are wasted.

Yardstick, and critical assessment

Perfect competition is a yardstick. Comparing a real market with it shows how far price is above MC and AC above its minimum: a misallocation of resources. This applies to labour markets too. A firm in a perfectly competitive labour market is a wage taker and hires until the marginal revenue product of labour equals the wage. A real wage below MRP points to market power.

To assess the proposition critically, test the assumptions:

• Externalities. Costs or benefits that fall on third parties are not in price, so P = MC can still overproduce a good such as one that pollutes.
• Scale. If minimum efficient scale is large compared with the market, many tiny firms cannot reach minimum AC. The model fits poorly.
• Dynamic efficiency. No long-run supernormal profit leaves little for research, and identical products give no variety.
• Information and entry. Real buyers lack perfect knowledge, and entry takes time.
• Distribution. An efficient allocation can still be unfair, because it depends on the income that buyers have.

A sound judgement: the model is a benchmark, not a description, and its efficiency conclusion needs all its assumptions.

3.3.3.3 Monopolistic competition

Characteristics

• A large number of firms, none with a big market share.
• Differentiated products, through brand, quality, design, location or service.
• Low barriers to entry and exit.
• Some price-making power, because customers see each product as different. Each firm’s demand curve slopes downward, and it is fairly elastic because close substitutes exist.
• Firms compete on non-price factors as well as price.

Short-run and long-run diagrams

Worked example (Bakery B, Town T, invented). Total cost is TC = 144 + 5q + 0.04q², so MC = 5 + 0.08q and AC = 144/q + 5 + 0.04q. Output is loaves a day.

Short run. Demand is P = 15 − 0.06q, so MR = 15 − 0.12q.

• MR = MC: 15 − 0.12q = 5 + 0.08q, so q = 50.
• Price = 15 − 0.06 × 50 = 12.00. AC = 9.88.
• TR = 600, TC = 144 + 250 + 100 = 494, so profit = 106, supernormal. Price is above AC at this output.
• Price elasticity of demand here = (1 ÷ 0.06) × (12 ÷ 50) = −4.0.

Long run. Supernormal profit attracts entry. Rivals take customers, so each bakery’s demand shifts left and becomes more elastic, until it just touches AC. Say demand is now P = 12.2 − 0.05q, so MR = 12.2 − 0.10q.

• MR = MC: 12.2 − 0.10q = 5 + 0.08q, so q = 40. Price = 10.20.
• AC at 40 = 3.60 + 5 + 1.60 = 10.20, so TR = TC = 408 and profit is zero.
• Elasticity = (1 ÷ 0.05) × (10.2 ÷ 40) = −5.1, so demand is more elastic than before.

In the long-run diagram, demand touches AC at q = 40, to the left of the lowest point of AC, and MR cuts MC at that output.

Where firms make losses, some leave. Each remaining firm’s demand then shifts right until it touches AC again.

Efficiency compared with perfect competition

With the same costs, AC is lowest at q = 60, where AC = MC = 9.80. A perfectly competitive firm would produce 60 at a price of 9.80.

Test	Perfect competition	Bakery B in the long run
Price against MC	9.80 = 9.80, allocatively efficient	10.20 against 8.20: price is 2.00 above MC
Output against minimum AC	60, productively efficient	40, so excess capacity of 20
Profit	Normal	Normal

Consumers pay 4.1% more than in perfect competition ((10.20 − 9.80) ÷ 9.80). Neither test is met, although customers do get variety.

Non-price competition

Firms compete through branding, advertising, design, quality, location, loyalty schemes and service. The specification asks you to see both sides.

• It strengthens monopoly power. Brand loyalty makes demand less elastic, giving more power over price, and a well-known brand makes entry harder.
• It can make markets more competitive. Firms keep improving products to win customers, and advertising informs buyers, so consumers gain choice and quality.

Worked example. Bakery B spends 30 a day on advertising, so fixed cost rises to 174. Demand shifts to P = 14 − 0.05q, so MR = 14 − 0.10q.

• MR = MC: 14 − 0.10q = 5 + 0.08q, so q = 50. Price = 11.50.
• TR = 575. TC = 174 + 250 + 100 = 524. Profit = 51.

The advertising pays, because profit rises from zero to 51. If rivals copy and demand returns to P = 12.2 − 0.05q, the bakery again sells 40 at 10.20. TR = 408 but TC = 174 + 200 + 64 = 438, a loss of 30. Everyone has spent more and the gain disappears.

Evaluation. Non-price competition benefits consumers when it gives real information or better quality, but not when it only builds a brand that costs more. It depends on whether advertising informs or merely persuades, how easily rivals copy, and whether entry stays easy.

Common errors

• Drawing a downward-sloping AR for a perfectly competitive firm, or letting it set its price.
• Shutting a firm down when price is below AC but above AVC.
• Saying supernormal profit lasts in the long run in perfect competition or monopolistic competition.
• Drawing monopolistic competition output at minimum AC and missing excess capacity.
• Claiming perfect competition is efficient without naming the assumptions.
• Describing non-price competition as only good, or only bad, for consumers.

Next steps

Continue with the revision notes and practice questions linked at the top, and check your progress with the diagnostics.

Official syllabus

Source: the OxfordAQA International AS and A-level Economics specification (9640), version 1.2, sections 3.3.3.1 to 3.3.3.3 and quantitative skills in 3.5.