OxfordAQA A-level Economics: Monopoly, monopoly power and the competitive market process (9640) – Revision Notes

These revision notes condense sections 3.1.4.4 (Monopoly and monopoly power) and 3.1.4.5 (The competitive market process) of the OxfordAQA International AS and A-level Economics (9640) specification, version 1.2. Section 3.1 is International AS content, which is also part of the International A-level. For full explanations, read the study guide. Test yourself with the practice questions, tick off the printable checklist, see the course hub and find gaps with the free diagnostics. All figures are invented.

Key definitions

Term	Meaning
Pure monopoly	One firm is the whole market and buyers have no close alternative. Few real examples.
Monopoly power	A firm’s ability to influence price or earn higher profit because competition is limited. Many firms have it.
Barriers to entry	Obstacles that raise the difficulty or cost for newcomers trying to join a market
Concentration ratio (CRn)	Total share held by the n leading sellers
Product differentiation	Features, branding or quality that make a firm’s product different from rivals’
Economies of scale	Falling long-run average cost as output rises
Misallocation of resources	Resources are not used where they would be most valued
Non-price competition	Rivalry through product quality, cost cutting and service rather than price alone

Factors that increase monopoly power

• Higher barriers to entry (start-up cost, legal protection, control of inputs, brands, large economies of scale)
• Fewer competitors, or very unequal sizes
• Advertising that builds loyalty or must be matched by entrants
• Greater product differentiation

Link in one chain: each factor makes demand less price elastic, so a price rise loses fewer customers, so the firm can raise price and profit.

Concentration ratios

Item	Rule
Formula	CRn = (combined sales of the n biggest sellers) divided by (whole-market sales), times 100
Measure	Use the same measure for all firms: revenue, output or employment
Total	Include every firm in the denominator, including the small ones grouped as “others”
Gap between two ratios	Use percentage points
Relative change	(new - old) / old x 100

Method in steps

1. Rank firms from largest to smallest.
2. Add the n largest.
3. Divide by the whole market total.
4. Multiply by 100.
5. Comment: high ratio suggests market power, but it says nothing about entry barriers or how closely rivals compete.

Worked reminder. Market sales (units): 120, 90, 60, 30 and 20 for five named firms, plus 80 for all others.

Total = 120 + 90 + 60 + 30 + 20 + 80 = 400. CR2 = 210/400 = 52.5%. CR3 = 270/400 = 67.5%.

If the firms with 60 and 30 merged, they would hold 90, joint second with the firm on 90. CR3 would be (120 + 90 + 90)/400 = 75%.

Percentage points versus per cent. A ratio moving from 40% to 46% is up 6 percentage points, which is a 15% relative rise (6/40).

Limits of concentration ratios: they depend on how the market is defined; they ignore potential entrants; they say nothing about how the firms behave; they do not show whether the largest firm dominates.

The basic model: monopoly versus competition

Compared with a competitive market, monopoly tends to give	Because
Higher price	The firm faces weak competition and can restrict output
Lower output	Moving up the demand curve to a higher price means fewer units are bought
Higher profit	Price is well above unit cost
Lower consumer surplus	Buyers pay more and buy less
Inefficiency and misallocation	Units that buyers value above their cost are not made

Demand curve skill. Draw or describe a downward-sloping demand curve. Mark the competitive price and its quantity. Mark the higher price and read off the smaller quantity. The specification does not require a formal diagram of monopoly.

Worked reminder. Demand: P = 50 - Q. Unit cost is 10 whoever produces.

• Competitive: price 10, output 40, profit 0, consumer surplus 0.5 x 40 x 40 = 800.
• Monopoly price 30: output 20, profit (30 - 10) x 20 = 400, consumer surplus 0.5 x 20 x 20 = 200.
• Surplus lost to everyone: 800 - 200 - 400 = 200.

Price rises 200% and output falls 50%.

Benefits of monopoly

Benefit	Reasoning	Evaluation
Economies of scale	One large firm can have lower LRAC than several small ones, saving resources	Only helps consumers if the saving is passed on
Invention and innovation	Profit can fund research, and patents reward risk	A firm without rivals may feel less need to improve. The specification says “possibly”

Worked reminder (LRAC). Output needed: 60,000 units. Two firms of 30,000 units each have LRAC of 12. One firm of 60,000 has LRAC of 9.

• Two firms: 2 x 30,000 x 12 = 720,000.
• One firm: 60,000 x 9 = 540,000.
• Saving 180,000, with unit cost down 25%.

If the monopolist prices between 9 and 12, consumers can still gain. If it prices above 12, the saving is mostly profit.

The competitive market process

• Competition is about more than price.
• Firms strive to improve products, reduce costs and improve service.
• Large firms often compete vigorously, which benefits consumers through price, quality and choice.
• Monopoly power weakens this pressure, so resources may be misallocated and consumers exploited.

Pass-through reminder. Unit cost falls from 20 to 18 (down 10%). Price falls from 30 to 28.50 (down 5%). Pass-on = 1.50/2.00 = 75% of the cost saving.

Evaluation checklist

1. How large are the economies of scale compared with the market?
2. Are cost savings passed on?
3. Is entry easy, so that the threat of rivals disciplines the firm?
4. Does profit fund innovation or complacency?
5. Is the position permanent, or will technology wear it away?
6. Which stakeholders gain or lose: consumers, workers, shareholders, suppliers?

A strong conclusion picks a side on the evidence in the question and says what would change your view.

Chains of reasoning to memorise

• Barrier raised: fewer new entrants, so fewer rivals, so less pressure on price, so higher profit can last.
• Advertising or differentiation: stronger loyalty, so demand is less price elastic, so a price rise loses fewer sales.
• Economies of scale: lower unit cost, so a lower price is possible, but only a firm that chooses to pass the saving on, or is made to, will cut price.
• Competition between large firms: each fears losing customers, so each improves product, cost or service, so buyers gain.
• Weak competition: less reason to improve, so price may be higher, output lower and resources used where they are less valued.

A short sketch can support these chains. For the demand curve, label the price axis and the quantity axis, mark the competitive price with its quantity, then mark the higher price with the smaller quantity and write “output falls” between the two points.

Must-know distinctions

• Pure monopoly versus monopoly power: single seller versus influence over price.
• Percentage points versus per cent.
• Large market share versus high barriers: share is today’s position, barriers protect it tomorrow.
• Cost saving versus price cut: a lower cost only helps buyers if the firm passes it on.
• Price competition versus non-price competition.

Quick self-test

1. State the difference between pure monopoly and monopoly power.
2. Name two factors that raise a firm’s monopoly power.
3. Sales in a market total 500 and the three largest firms sell 150, 120 and 80. Calculate CR3.
4. A market’s CR4 moves from 60% to 66%. Give the change in percentage points and the relative change.
5. Explain one limit of using a concentration ratio on its own.
6. Demand is P = 50 - Q and unit cost is 10. Output at a price of 30?
7. Using question 6, by how much does the output fall compared with price 10?
8. Name one possible benefit of monopoly, and one reason it may not reach consumers.
9. Give two ways firms compete other than by price.
10. A firm’s unit cost falls from 40 to 36 and its price from 60 to 57. Calculate the share of the cost saving passed on.

Answers

1. Pure monopoly is a single seller in the whole market. Monopoly power is the ability to influence price, which many firms have without being the only seller.
2. Any two from: barriers to entry, fewer competitors, advertising, product differentiation.
3. (150 + 120 + 80)/500 = 350/500 = 70%.
4. 6 percentage points; 6/60 = 10% relative rise.
5. For example: it ignores barriers and potential entrants, or it depends on how the market is defined.
6. 50 - 30 = 20 units.
7. At price 10 output is 40, so it falls by 20 units, a 50% fall.
8. Economies of scale (or invention and innovation). The firm may keep the saving as profit instead of cutting price.
9. For example: better product quality and faster service.
10. Cost saving 4; price cut 3; 3/4 = 75%.

Where marks are usually lost

• Calling a firm with high market share a pure monopoly.
• Leaving small firms out of the denominator.
• Mixing up percentage points and per cent.
• Writing “price rises, so profit rises” without saying that unit cost matters too.
• Listing benefits of monopoly with no evaluation of whether consumers share them.
• Drawing a full monopoly diagram that was not asked for and adding no analysis.
• Treating competition as price only.
• Concluding with “it depends” and no reasons.

Official syllabus

OxfordAQA International AS and A-level Economics (9640) specification, version 1.2, sections 3.1.4.4 and 3.1.4.5. First teaching September 2020, first AS exams May/June 2021, first A-level exams May/June 2022. Published by OxfordAQA.