How do monopoly, oligopoly and monopolistic competition set price and output, and are they good or bad for welfare?
1.4 Imperfect competition: monopolistic competition, oligopoly and interdependence, monopoly and price discrimination, and the costs and benefits of monopoly power.
An OCR H460 answer to imperfect competition, covering monopolistic competition, oligopoly and interdependence (collusion, price wars and non-price competition), monopoly and price discrimination, and the costs and benefits of monopoly power.
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What this dot point is asking
OCR wants you to explain monopolistic competition, oligopoly and the interdependence of firms (collusion, price wars and non-price competition), monopoly and price discrimination, and to evaluate the costs and benefits of monopoly power.
Monopolistic competition
In the short run a firm can earn supernormal profit by differentiating its product. But low barriers mean new firms enter, eroding each firm's demand until, in the long run, only normal profit remains. The outcome is neither fully allocatively nor productively efficient (price exceeds marginal cost and the firm does not produce at minimum average cost), but the inefficiency is small and consumers gain variety and choice.
Oligopoly and interdependence
Game theory (such as the prisoner's dilemma) shows why firms may collude yet face a constant temptation to cheat, and why competition authorities police cartels heavily.
Monopoly and price discrimination
Price discrimination is charging different consumers different prices for the same good for reasons not based on cost, to capture more consumer surplus. It requires market power, the ability to separate markets, and different price elasticities between groups (charging the inelastic group more). Examples include peak and off-peak rail fares, student and adult cinema tickets, and airline pricing. It raises producer profit but can also widen access (some consumers are served who otherwise would not be).
The costs and benefits of monopoly power
- Costs. Higher prices and lower output, allocative inefficiency (), productive inefficiency (not at minimum AC), possible X-inefficiency (slack from lack of competition), and a transfer of consumer surplus to the firm.
- Benefits. Economies of scale can make a single large firm a low-cost natural monopoly (water, rail networks); supernormal profit can fund dynamic efficiency (research, innovation, new products); and price discrimination can extend access. Regulation (price caps, the CMA) can curb the abuses while keeping the benefits.
Examples in context
- Utilities as natural monopolies. Water and rail infrastructure have huge economies of scale, so a single network is efficient, but it is regulated (Ofwat, the ORR) to prevent abuse.
- Supermarket oligopoly. The UK grocery market is a tight oligopoly with heavy non-price competition (loyalty cards, own-brands) and occasional price wars.
- Airline price discrimination. Carriers charge widely different fares for the same seat by booking time and class, the textbook example of separating markets by elasticity.
Try this
Q1. State the three conditions needed for price discrimination. [3 marks]
- Cue. Market power, ability to separate markets and prevent resale, and different price elasticities between groups.
Q2. Explain one benefit of monopoly power for consumers. [4 marks]
- Cue. For example economies of scale lowering costs (and potentially prices), or supernormal profit funding innovation (dynamic efficiency).
Exam-style practice questions
Practice questions written in the style of OCR exam questions on this dot point, with worked answer explainers. The year tag is the paper they imitate, not the source.
OCR H460/01 20195 marksExplain why a monopoly is allocatively inefficient.Show worked answer →
A short structured question. State that a monopoly is a single seller protected by high barriers to entry, so it is a price-maker facing a downward-sloping demand curve, with marginal revenue below average revenue.
Develop the chain: the monopolist profit-maximises where , then charges the higher price read off the demand curve above that output. Because price (AR) exceeds marginal cost at this output (), the value consumers place on an extra unit exceeds its cost, so too little is produced. This is allocative inefficiency, with a welfare loss compared with the competitive outcome where .
Markers reward the output, the point, and the conclusion of under-production and welfare loss.
OCR H460/01 202212 marksEvaluate the view that monopoly power is always against the interests of consumers.Show worked answer →
A levels-of-response question. Knowledge and application: define monopoly and explain the standard case against it: higher prices, lower output, allocative inefficiency (), productive inefficiency (not at minimum AC) and possible X-inefficiency, with supernormal profit transferred from consumers.
Analysis: develop the welfare loss and the harm to consumers.
Evaluation: set against this the benefits: economies of scale can lower costs (a natural monopoly), supernormal profit can fund dynamic efficiency (research and innovation), and price discrimination can widen access. Regulation can curb abuse. Conclude with a supported judgement: monopoly power can harm consumers but need not always, depending on economies of scale, innovation and regulation.
Related dot points
- 1.4 Market structures: the spectrum of competition, the characteristics and outcomes of perfect competition, barriers to entry and exit, and the theory of contestable markets.
An OCR H460 answer to market structures, covering the spectrum from perfect competition to monopoly, the assumptions and short-run and long-run outcomes of perfect competition, barriers to entry and exit, and the theory of contestable markets.
- 1.4 Costs, revenues and profit: fixed and variable costs, marginal, average and total cost, the law of diminishing returns, economies and diseconomies of scale, total, average and marginal revenue, and normal and supernormal profit.
An OCR H460 answer to costs, revenues and profit, covering fixed and variable costs, marginal, average and total cost, the law of diminishing returns, internal and external economies and diseconomies of scale, the revenue concepts, and normal versus supernormal profit.
- 1.4 Business objectives: profit maximisation, revenue and sales maximisation, growth, satisficing and corporate social responsibility, and the principal-agent problem from the divorce of ownership and control.
An OCR H460 answer to business objectives, covering profit maximisation at MC equals MR, revenue and sales maximisation, growth, satisficing and corporate social responsibility, and the principal-agent problem that arises from the divorce of ownership and control.
- 1.4 The labour market: the demand for and supply of labour, wage determination in competitive labour markets, monopsony, trade unions, and the effect of a national minimum wage.
An OCR H460 answer to the labour market, covering the derived demand for and supply of labour, wage determination in a competitive labour market, monopsony employers, trade unions and collective bargaining, and the employment effects of a national minimum wage.
Sources & how we know this
- OCR A Level Economics (H460) Specification — OCR (2023)