Monopoly

50 marks: 12 multiple choice questions, a data response and an essay. Answers are at the end.

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1A monopolist's marginal revenue lies below its average revenue because:

A its marginal cost rises as output increases, which reduces the revenue from each extra unit
B it faces a perfectly elastic demand curve, so each extra unit sells for less than the one before
C to sell one more unit it must lower the price on every unit it sells
D it earns normal profit in the long run, so the revenue from the last unit only covers its cost

2On a monopoly diagram, the area of abnormal profit at the profit-maximising output is:

A (price minus marginal cost) multiplied by output
B the triangle between demand and marginal cost beyond the chosen output
C total revenue minus total variable cost
D (price minus average cost) multiplied by output

3A firm earns normal profit when:

A average revenue equals marginal cost
B average revenue equals average cost
C total revenue is at its maximum
D marginal revenue equals marginal cost

4Which of the following is a legal barrier to entry?

A a patent on the firm's production process
B strong brand loyalty built by years of advertising
C economies of scale enjoyed by the existing firm
D the high sunk costs of entering the market

5A natural monopoly has long-run average cost falling over the whole range of market demand. If a regulator forces it to set price equal to marginal cost, the firm will:

A make a loss, because average cost is above marginal cost at that output
B earn abnormal profit, because output rises and the extra units are sold above their average cost
C be unaffected, since a profit-maximising natural monopoly already sets price equal to marginal cost
D produce at the lowest point of its average cost curve, which is where price equals marginal cost

6A cinema charges students less than adults for the same film. For this to raise its profit:

A the cinema must be in a perfectly competitive market, so that it is able to sell as many tickets as it wishes
B students must have higher incomes than adults, so that the discount persuades them to visit more often
C the cost of serving students must be lower than the cost of serving adults by at least the size of the discount
D students' demand must be more price elastic than adults' and resale between the groups must be prevented

7A monopolist cuts its price from £10 to £9 and weekly sales rise from 100 to 110 units. The change in its total revenue is:

A a rise of £990
B a fall of £100
C a fall of £10
D a rise of £90

8A monopolist is allocatively efficient only if it produces where:

A marginal revenue equals marginal cost
B price equals marginal cost
C average cost is at its minimum
D average revenue equals average cost

9A monopolist's average costs are higher than they need to be because the absence of competitive pressure allows waste and slack. This is called:

A allocative inefficiency
B X-inefficiency
C dynamic inefficiency
D diseconomies of scale

10When a firm with monopoly power moves from a single price to third-degree price discrimination, the group that loses is:

A the consumers with the more elastic demand, who now pay a lower price than before
B the firm, whose total revenue falls because it is no longer charging every customer the same price
C all consumers, since the firm uses its market power to raise the price for every group it serves
D the consumers with the less elastic demand, who now pay a higher price

11An argument in favour of monopoly is that abnormal profit:

A attracts new firms into the market, which restores allocative efficiency in the long run
B is always passed on to consumers in the form of lower prices once the firm's costs have been covered
C can fund research and development, leading to dynamic efficiency
D guarantees that price is set equal to marginal cost, so the market is allocatively efficient

12Compared with a single-price monopoly, a monopolist practising perfect (first-degree) price discrimination:

A produces a higher output and leaves consumers with no consumer surplus
B produces the same output and earns less profit, because some customers now pay a lower price
C produces a higher output and charges every customer a lower price than the single-price monopolist
D produces a lower output and charges every customer the same price for each unit sold

13Britain's rail track, signals and stations are owned and run by Network Rail, a public body, while train services are run by operating companies under contract. Operators charge different fares for the same journey depending on when the ticket is bought and the time of travel. Table 1 shows fares for a standard-class single on one intercity route. Figures are illustrative.

Table 1: Fares for the same journey
Ticket	When it can be used	Fare
Advance	One named train, bought at least a day ahead	£40
Off-peak	Any train outside the morning and evening peaks	£90
Anytime	Any train, including peak times	£180

(a)Using Table 1, calculate the percentage by which the anytime fare exceeds the advance fare. [2]

(b)Explain two conditions that allow a train operator to charge different fares for the same journey. [4]

(c)With the aid of a diagram, explain how charging commuters more than leisure travellers can increase an operator's profit. [6]

(d)Explain why the rail track network is considered a natural monopoly, and why this makes competition between track owners undesirable. [6]

14Evaluate the view that price discrimination always harms consumers. [20]

Answers

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	Answer	Why
1	C	With a downward-sloping demand curve, the extra unit brings in its price minus the revenue lost on all the earlier units now sold more cheaply.
2	D	Profit per unit is price minus average cost; multiplied by the number of units it gives the rectangle of abnormal profit.
3	B	Normal profit is the minimum needed to keep the firm in the industry and is counted in its costs, so AR = AC means normal profit only.
4	A	A patent is created by law and makes it illegal for rivals to copy the process; the others are strategic or structural barriers.
5	A	When average cost is falling, marginal cost is below it, so a price equal to marginal cost does not cover average cost.
6	D	Third-degree price discrimination raises profit when groups with different elasticities can be separated; costs are the same for both.
7	C	Total revenue falls from £1,000 to £990. The ten extra units bring in £90 but the 100 existing units each sell for £1 less, so marginal revenue is negative: demand is price inelastic here.
8	B	Allocative efficiency requires the value consumers place on the last unit (price) to equal the cost of the resources used to make it (MC).
9	B	X-inefficiency is cost above the minimum attainable because the firm is under no pressure to control it.
10	D	The firm raises price where demand is inelastic and lowers it where demand is elastic, so the inelastic group pays more and loses consumer surplus.
11	C	Retained profit is a source of finance for innovation; whether it is used that way is a matter for evaluation.
12	A	Charging each buyer the most they will pay makes MR equal to price, so the firm sells every unit for which price exceeds MC and takes all the surplus.

13 (a) Using Table 1, calculate the percentage by which the anytime fare exceeds the advance fare. [2]

(180 − 40) ÷ 40 × 100 (1 mark)
350% (1 mark)

13 (b) Explain two conditions that allow a train operator to charge different fares for the same journey. [4]

Market power: the operator is the only firm running trains on the route, so it is a price maker and can set fares above marginal cost (1 mark for the condition, 1 for explaining it in context)
Separable groups with different price elasticities of demand: commuters who must travel at peak times have inelastic demand, leisure travellers who can book ahead or travel off-peak have elastic demand (1 mark for the condition, 1 for the context)
Also credit: no resale between groups, because tickets are tied to a time or a named train and are checked on board (1 mark for the condition, 1 for the context)
Maximum 4: two conditions, each explained in context.

13 (c) With the aid of a diagram, explain how charging commuters more than leisure travellers can increase an operator's profit. [6]

Diagram: two sub-markets side by side with the same marginal cost; commuters with a steep (inelastic) AR and MR, leisure travellers with a flatter (elastic) AR and MR; output in each where MC = MR; a higher price read off the commuter AR and a lower price off the leisure AR (2 marks)
The operator sets MC = MR in each market separately; because the marginal revenue curves differ, the profit-maximising price differs (1 mark)
Raising the peak fare loses few commuters (inelastic), so revenue from them rises; lowering the off-peak fare attracts many leisure travellers (elastic), so revenue from them rises too (2 marks)
Costs are the same per passenger whichever fare is paid, so the extra revenue is extra profit; the firm also captures consumer surplus that a single price would have left with passengers (1 mark)
Levels: 1 to 2 for a description with a partly correct diagram; 3 to 4 for correct diagrams with MC = MR in each market; 5 to 6 for the elasticity reasoning tied to the two fares and the link to profit.

13 (d) Explain why the rail track network is considered a natural monopoly, and why this makes competition between track owners undesirable. [6]

A natural monopoly exists where long-run average cost keeps falling over the whole range of market demand, so one firm can supply the market at lower average cost than two or more could (1 mark)
The track network has very high fixed costs (laying and maintaining track, signalling, stations) and low marginal costs of running an extra train, so average cost falls as use rises (1 mark); the minimum efficient scale is at or beyond the size of the whole market (1 mark)
Competition would mean duplicating the track: each owner would carry the same fixed costs for a share of the traffic, so average cost, and fares, would be higher than with one network (1 mark)
So the usual case for competition (lower prices through rivalry) fails; a single regulated network, or public ownership as with Network Rail, is the lower-cost outcome (1 mark)
A diagram of a falling LRAC with market demand cutting it while it is still falling, or a well-chosen example, earns the final mark (1 mark)

14 Evaluate the view that price discrimination always harms consumers. [20]

Analysis

Define price discrimination: charging different prices to different consumers for the same product where the difference is not explained by cost; the conditions (market power, separable groups with different PED, no resale); degrees (first, second, third), with the third-degree diagram showing a higher price in the inelastic market and a lower one in the elastic market.
The case that it harms consumers: consumer surplus is transferred to the producer; the group with inelastic demand pays more than under a single price; under perfect price discrimination consumer surplus falls to zero; it can be used to drive rivals out of a market (predatory pricing in one segment subsidised by profits in another); it can feel unfair, as with pricing by area or by what a buyer's data suggests they can afford.
The case that it can help consumers: the group with elastic demand pays less, and some who were priced out of the market at the single price can now buy (students, off-peak travellers, pensioners); total output rises, which moves the market towards the allocatively efficient output; the extra profit may fund investment, better services or innovation (dynamic efficiency); in industries with high fixed costs, such as rail, airlines or software, price discrimination may be what allows the service to run at all.
Cross-subsidy: profits from the inelastic group may keep loss-making services going that a single price would close (rural rail lines, off-peak trains).
Diagram to use: third-degree price discrimination with two sub-markets and the combined market, showing the gain in profit; optionally perfect price discrimination showing output at P = MC and zero consumer surplus.

Evaluation

It depends which consumers: those with inelastic demand lose, those with elastic demand gain; 'consumers' are not one group, so 'always' is too strong.
It depends on the degree: perfect price discrimination removes all consumer surplus; third-degree redistributes it and can raise total output.
It depends on what the firm does with the profit: reinvested in capacity or innovation it benefits future consumers, paid out as dividends it does not.
It depends on the market: where price discrimination allows a high-fixed-cost service to exist at all, consumers as a whole gain compared with no service.
It depends on regulation: competition authorities can act against discrimination that forecloses rivals while allowing the kind that widens access.

Judgement

A supported judgement might conclude that price discrimination does not always harm consumers: it reliably harms the inelastic group and reliably helps the elastic group, and whether consumers as a whole gain depends on whether output rises, how the extra profit is used and whether the market would be served at all without it. A blanket ban would remove the gains along with the losses; the case for intervention is strongest where discrimination is used to exclude rivals.

Marking

Top band (16 to 20): a range of points developed in full chains of reasoning, supported by an accurate diagram and real examples, with evaluation that weighs the arguments and reaches a judgement that depends on stated conditions. Middle band (9 to 15): some developed chains, a relevant diagram, evaluation that is present but one-sided or asserted. Bottom band (1 to 8): points listed or described, little use of theory or examples, judgement missing or unsupported.