How does the number of firms in a market shape price, output and efficiency?
Perfect competition, monopolistic competition, oligopoly and monopoly, their assumptions and outcomes, price and non-price competition, and types of efficiency.
An Edexcel A-Level Economics A answer to market structures, covering perfect competition, monopolistic competition, oligopoly and monopoly, their assumptions and short-run and long-run outcomes, price and non-price competition, collusion, price discrimination, and allocative, productive, dynamic and X-efficiency.
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What this dot point is asking
Edexcel wants you to compare the four market structures, analyse their price and output outcomes on diagrams, explain price and non-price competition and price discrimination, and evaluate them against the four types of efficiency.
The four structures
Oligopoly behaviour
Game theory (the prisoner's dilemma) shows why firms may both undercut even though collusion would be jointly better, and why cartels are unstable. Price discrimination is charging different prices to different consumers for the same good; it needs market power, the ability to separate consumers and prevent resale, and different price elasticities of demand. It raises producer profit and can raise output.
Efficiency
- Allocative efficiency: price equals marginal cost (), so resources match consumer preferences. Achieved in perfect competition, not monopoly (where ).
- Productive efficiency: output at the lowest average cost (the bottom of the AC curve).
- Dynamic efficiency: investment and innovation over time, helped by the supernormal profit of monopolies and oligopolies (the Schumpeterian argument).
- X-efficiency: keeping costs at the minimum; monopolies may be X-inefficient because they lack competitive pressure.
Examples in context
- UK supermarkets. A classic oligopoly: a handful of chains with high concentration competing heavily on non-price terms (loyalty cards, ranges).
- Google search. A near-monopoly with very high barriers and large supernormal profit, raising allocative-efficiency and regulatory concerns.
- Airline pricing. Dynamic pricing by seat and time is real-world price discrimination by elasticity.
- Farming. Close to perfect competition: many price-taking producers selling a homogeneous commodity, earning around normal profit long run.
Try this
Q1. Explain why a firm in perfect competition earns only normal profit in the long run. [4 marks]
- Cue. Free entry: supernormal profit attracts new firms, raising supply and lowering price until only normal profit remains.
Q2. Explain one reason a monopoly may be allocatively inefficient. [3 marks]
- Cue. It profit-maximises where , restricting output and setting price above marginal cost ().
Exam-style practice questions
Practice questions written in the style of Pearson Edexcel exam questions on this dot point, with worked answer explainers. The year tag is the paper they imitate, not the source.
Edexcel 20194 marksThe three largest firms in a market have shares of , and . Calculate the three-firm concentration ratio and state what market structure it suggests.Show worked answer →
A short calculate question on concentration.
Three-firm concentration ratio .
A high concentration ratio (well above ) with only a few dominant firms suggests an oligopoly, where firms are interdependent.
Markers reward (1) summing the top three shares to , (2) identifying oligopoly, (3) linking high concentration to interdependence.
Edexcel 202315 marksEvaluate the view that monopoly always reduces economic welfare compared with perfect competition.Show worked answer →
A 15 mark evaluate question (around 9 KAA, 6 evaluation).
KAA: contrast the perfectly competitive long-run equilibrium (, normal profit, allocative and productive efficiency) with monopoly (output where , , supernormal profit, allocative inefficiency and a deadweight welfare loss), with diagrams.
Evaluation: monopoly can reap economies of scale (lower costs and prices, a natural monopoly), fund dynamic efficiency through R&D financed by supernormal profit, and engage in price discrimination that can raise output. Reach a judgement that welfare effects depend on economies of scale, innovation and regulation.
Markers reward two diagrams, the deadweight-loss point and balanced evaluation.
Related dot points
- Total, average and marginal revenue and cost, the law of diminishing returns, economies and diseconomies of scale, and normal and supernormal profit.
An Edexcel A-Level Economics A answer to revenues, costs and profits, covering total, average and marginal revenue and cost, the law of diminishing marginal returns in the short run, internal and external economies and diseconomies of scale, and the difference between normal and supernormal profit.
- Profit maximisation and the MC equals MR rule, and alternative objectives including revenue maximisation, sales maximisation, satisficing and survival.
An Edexcel A-Level Economics A answer to business objectives, covering profit maximisation where marginal cost equals marginal revenue, and the alternative objectives of revenue maximisation, sales maximisation, satisficing, survival and ethical or social aims.
- Competition policy, regulation of monopolies and mergers, price and profit regulation of natural monopolies, protection of suppliers and employees, and the limits of intervention.
An Edexcel A-Level Economics A answer to government intervention to control firms, covering competition policy and the Competition and Markets Authority, the regulation of monopolies and mergers, price-capping and profit regulation of natural monopolies, protection of suppliers and employees, and the limits of regulation including regulatory capture.
- The reasons firms grow or stay small, organic and inorganic growth, types of integration, the principal-agent problem and the divorce of ownership from control.
An Edexcel A-Level Economics A answer to business growth, covering why firms grow or remain small, organic versus inorganic growth, horizontal, vertical and conglomerate integration, demergers, and the principal-agent problem arising from the divorce of ownership and control.
Sources & how we know this
- Pearson Edexcel A-Level Economics A (9EC0) specification — Pearson Edexcel (2015)