Theory of the Firm Questions, 2006 - 2011
Syllabus
Year, Paper
Question
Student Outline Response
Barriers
2007 May P1
1. (a) Explain how barriers
to entry may affect market
structure. [10 marks]
Answers may include:

explanation of term barriers to entry

examples of barriers to entry, such as patents, economies of
scale and ownership and control of raw materials

explanation of term market structure

identification of the different types of market structure, i.e.
perfect competition, monopoly, monopolistic competition and
oligopoly

explanation that there are no barriers to entry in perfect
competition

linkages between no entry barriers and perfect competition and
monopolistic competition

explanation that entry barriers exist in the other market forms

linkages between the existence of entry barriers in monopoly and
oligopoly and market structure
Economies
of scale
2007 May P2
3. Explain the law of
diminishing returns using
average and marginal
product curves.
Answers may include:

definition of the short-run

definition of law of diminishing returns

increasing output initially increases MP which pulls up AP

as fixed factors are increasingly employed, so changes in MP and
AP slow down and reverse

MP cuts AP from above

carefully labelled diagrammatic representation
Examiners should be aware that candidates may take a different
approach which, if appropriate, should be fully rewarded.
M
2010 May P2
2. With the aid of at least
one diagram, explain one
way a consumer might gain
from the behaviour of
a monopolist and one way
a consumer might lose
from the behaviour of a
monopolist.
M
2009 November P1
1. (a) Explain why a firm
Candidates may include:

a definition of a monopolist graphical representation of a
monopoly market structure.

Gains to the consumer: economies of scale innovation use of a
diagram to illustrate how the above can lead to gains for the
consumer.

Losses to the consumer: compared to a competitive industry, it
will charge consumers a higher price compared to a competitive
industry, it will have a lower level of output compared to a
competitive industry, it will result in lower consumer surplus it
will give rise to productive and allocative inefficiency use of a
diagram to illustrate consumer losses, or productive and
allocative inefficiency.
Answers should include:
1
Syllabus
Year, Paper
Question
may practice price
discrimination and the
necessary
conditions for it to take
place. [10 marks]
Student Outline Response


a definition of price discrimination
an explanation that the aim of price discrimination is to increase
profit an explanation of the various conditions; i.e. some degree
of monopoly control of the market, ability to split the market into
different segments and to prevent reselling between the markets,
and different elasticities of demand in the different markets.
Answers may include:

appropriate diagrammatic illustration of price discrimination

reference to the connection between price discrimination and
consumer surplus and the supplier’s intention of transferring the
surplus from consumers to producers

a distinction between price discrimination and the charging of
different prices for the same product/service where distribution
and/or production costs are different (price discrimination is not
the result of cost differences)

an explanation of how it is consistent with the objective of profit
maximization

a distinction between first, second and third degree price
discrimination.
M
M
2007 November P2
2006 November P1
3. Explain the concept of a
natural monopoly.
1. (a) Explain the
necessary conditions for
price discrimination to take
place. [10 marks]
Answers may include:

definition: occurs when one large firm can supply the entire
market at a lower price than two or more smaller ones

explanation that the market is characterized by increasing returns
to scale at all levels of output

identification of economies of scale: production, managerial,
financial and marketing

diagram illustrating a market with a continually falling average
cost curve and showing that the marginal cost curve lies below
the average cost curve

explanation, using the diagram, that if the market is provided for
by two or more firms the average total cost will rise resulting in
lower productive efficiency

examples of markets where natural monopolies are to be found
e.g. railways

To reach levels 3 and 4 candidates should demonstrate clear
ability to apply relevant theory and/or to analyse using relevant
theory.
Candidates may include any of the following:
• definition of price discrimination
• the ability to set market price
• the ability to separate the market segments
• separation and splitting of markets based on time, place and income
• PED must differ in each market
2
Syllabus
Year, Paper
Question
M
2006 November P1
1.(b) Discuss the
advantages and
disadvantages of price
discrimination for
consumers and producers.
[15 marks]
M
2007 May P1
1. (b) Evaluate the view
that monopoly is an
undesirable type of market
structure. [15 marks]
Student Outline Response
• examples of price discrimination
• degrees of price discrimination
Candidates may include any of the following:
• effects on consumers
• effects on producers
• appropriation of consumer surplus (a diagram may be used)
• effect on competition
• effect on profits
• redistributive effects
• predatory pricing advantages
• diagram showing separation of markets
• advantages and disadvantages may be illustrated with examples
Examiners should be aware that candidates may take a different
approach, which if
appropriate should be rewarded.
Effective evaluation may be to:
• consider short run versus long run consequences
• examine the impact on different stakeholders
• discuss advantages and disadvantages
• prioritize the arguments
Answers may include:

definition of monopoly

at least one appropriate diagram

comparisons between monopoly and perfect competition, e.g.
price usually higher and output lower

allocative and productive inefficiency

failure by monopolist to produce at the socially optimum level of
output

lack of choice for consumers

lack of innovation and higher unit costs because of absence of
competition

possibility of lower unit costs and prices owing to economies of
scale

long run dynamic efficiency in monopoly

benefits of natural monopoly

benefits to some consumers of monopolistic price discrimination

potential competition and contestable markets
Examiners should be aware that candidates may take a different
approach, which if appropriate, should be rewarded. Effective evaluation
may be to:
consider short run versus long run consequences
examine the impact on different stakeholders
discuss advantages and disadvantages
prioritize the arguments
3
Syllabus
Year, Paper
Question
Student Outline Response
M & PC
2006 May P2
3. Using appropriate
diagrams, discuss whether
monopoly is more efficient
or less efficient than
perfect competition.
MC
2007 November P1
1. (a) Explain the
difference between shortrun equilibrium and longrun
equilibrium in monopolistic
competition. [10 marks]
Answers may include:
• definitions of efficiency: allocative and productive efficiency
• the firm in perfect competition: in long-run equilibrium the firm is
allocatively and
productively efficient
• correctly drawn and labelled diagram
• explanation of perfect competition
• the firm in monopoly in long-run equilibrium the firm is neither
allocatively nor
productively efficient
• correctly drawn and labelled diagram
• explanation of monopoly
• dynamic efficiency: increased profits of monopoly used for investment
leading to greater
output and lower prices than in perfect competition (economies of scale)
• correctly drawn and labelled diagram
Candidates may include the assumptions of monopolistic competition,
which may include:

large number of firms

very elastic demand

firms are small relative to the size of the market

no or low barriers to entry or exit

perfect knowledge in the market

product differentiation

firms are short-run profit maximisers.
Candidates may include the difference between short-run equilibrium and
long-run equilibrium, which may include:

distinction between short run and long run

definition of equilibrium

explanation of profit maximization

firms can make abnormal profits (economic profits) in the shortrun

abnormal profits (economic profits) will attract new entrants into
the market

demand for existing firms falls

the process continues until normal profits (zero economic profits)
are made in the long-run.
Diagrams for short-run profit and for long-run normal profit are expected.
If candidates approach the question from the perspective of short-run
losses, they can be fully rewarded.
MC
2009 May P3
2(b) Using an appropriate
diagram, explain how a
firm in monopolistic
For drawing a correctly labelled diagram illustrating a firm in monopolistic
competition producing at MC=MR and making abnormal (economic)
profits and for providing an explanation of the conditions under which a
4
Syllabus
MC
Year, Paper
2009 May P3
Question
Student Outline Response
competition
can earn
abnormal/economic profit.
[4 marks]
firm in monopolistic competition would earn abnormal (economic) profits
in the SR.
For full marks, candidates must accurately show the relationship between
AC and MC, that is, MC must cross AC at the minimum of AC.
Candidates who incorrectly label diagrams cannot be rewarded with full
marks.
The horizontal axis should be quantity or output. The vertical axis should
be costs, revenues, “price and costs”, “price and revenues”, “costs and
revenues”, price or a currency symbol. A title is not necessary.
Responses may include:
Consumers:
choice and variety resulting in better quality, larger range of services,
quality of conversation etc. (paragraph )
greater competition among producers as a result of more firms coming
into the industry and forcing prices down, benefiting consumers
(paragraph ), prices may be higher than in perfect competition (excess
capacity that characterises monopolistic competition implies that prices
are higher than they need be).
2(d) Using information
from the text/data and
your knowledge of
economics,
evaluate the costs and
benefits of monopolistic
competition for consumers
and producers. [8 marks]
Producers:
differentiation of services can lead to consumer loyalty (paragraph )
consumer loyalty can allow a degree of independence in price setting
(paragraph )
abnormal (economic) profits can be earned in short run (paragraph )
easy exit for firms (paragraph )
incur additional costs as they are forced to differentiate
firms can only earn normal profits in the LR
high risk of failure due to intense competition
any reasonable answer.
Examiners must be aware that candidates may take a different approach
which if appropriate, should be rewarded.
If there is no direct reference to the data, then candidates may not be
rewarded beyond level 2.
Effective evaluation may be to:
consider short-term versus long-term consequences
examine the impact on different stakeholders
discuss advantages and disadvantages
prioritize the arguments.
O
2009 November P2
3. Explain the nature of
competition in a noncollusive oligopoly.10
marks
Answers may include:

definition of the market structure of an oligopoly

characteristics of the market structure with the emphasis on
interdependence

distinction between collusive and non-collusive oligopolies

diagrammatic representation of the kinked demand curve as a description
5
Syllabus
Year, Paper
Question
O
2009 May P2
2. Explain why prices tend
to be relatively stable in a
non-collusive oligopoly. 10
marks
O
2008 May P1
1. (a) Explain how a firm
operating in an oligopolistic
market might attempt to
increase its market share.
[10 marks]
O
2008 May P1
1. (b) Evaluate the view
that producers, and not
consumers, are the main
beneficiaries of oligopolistic
market structures. [15
marks]
Student Outline Response
of a non-collusive oligopoly

explanation of the kinked demand curve (with reference to the diagram) as
a justification for non-price competition
examples of non-price competition:
– product differentiation
– increased inducements to consumers to purchase a largely unchanged product:
gifts and coupons for example
– advertising/marketing.
Candidates may include any of the following:

definition and explanation of an oligopoly market structure

distinction between a collusive and non-collusive oligopoly

explanation of why prices may not change – the notion of
interdependence

the kinked demand curve – diagrammatic representation

explanation of the kinked demand curve – elastic and inelastic
segments of the curve

the discontinuous marginal revenue curve

non-price competition such as advertising

explanation of why, despite their relative stability, prices may
change in a non-collusive oligopoly:
– price change operated by market leaders
– long-run changes leading to economies of scale and lower LRACs.
Answers should include:
• definition of oligopoly
• explanation of market share
• an explanation of some of the ways a firm in an oligopolistic market
can increase its market share.
The ways may include:
• price wars
• the creation of entry barriers
• take-overs and mergers
• collusion
• the use of product differentiation to create brand loyalty
• the use of advertising and other forms of non-price competition
• the exploitation of large scale production and economies of scale.
Candidates who are able to fully explain at least two ways can access the
top mark band.
Answers may include:
• the advantages and disadvantages to the producer of being in an
oligopoly
• the advantages and disadvantages to consumers
• distinction between collusive and non-collusive oligopoly
• notion of joint profit maximization
• impact of collusion in reducing uncertainty for firms
• impact of cartels in restricting output and raising prices charged
6
Syllabus
Objectives
Year, Paper
2009 November P1
Question
1. (b) “Although a firm
may pursue a range of
goals, economists usually
assume that
profit maximization is the
main goal.” Discuss this
statement. [15 marks]
Student Outline Response
• impact of oligopoly on different types of efficiency
• impacts on producer and consumer sovereignty
• advantages/disadvantages of non-price competition for consumers and
producers
• implications of kinked demand curve model for producers and
consumers
• possibility of market contestability and the implications thereof.
Answers not referring to benefits that consumers may receive from
an oligopolistic market structure cannot reach the top mark band.
Answers may include:

a definition of profit of maximization in terms of MC = MR and/or
where TR most exceeds TC

explanation that the conventional theory of the firm assumes the
MC = MR profit maximizing rule under the various market
structures

explanation of the setting of prices using MC = MR in different
market structures, e.g. perfect competition, monopoly, oligopoly,
monopolistic competition

explanation of why firms may not set prices according to MC =
MR, e.g. may not have the profit maximizing objective, may lack
relevant information on costs and revenues

discussion of how firms may set prices in reality, e.g. in terms of
sales volume maximization, revenue maximization, environmental
concerns

discussion of influence of government e.g. nationalized industries,
regulatory bodies, taxation

assessment of the extent to which the conventional theory of the
firm is relevant to the real world

appropriate theory of the firm diagram.
Effective evaluation may be to:
consider short-term versus long-term consequences
examine the impact on different stakeholders
discuss advantages and disadvantages
prioritise the arguments.
Objectives
2006 November P2
2. A monopoly firm decides
to maximize revenue
rather than profit. Use a
diagram to explain what
will happen to price and
quantity.
PC
2011 May P1
1. (a) Using at least one
Candidates may include any of the following:
• definition of monopoly
• distinction between revenue and profit
• diagram including an AR(D), MR and MC curve
• diagram should show profit maximizing level of output (MC = MR)
• diagram should show revenue maximizing level of output (MR = 0)
• an explanation that when there is a move from profit maximization to
revenue maximization, output will increase and the price of the good will
fall
Answers should include:
7
Syllabus
Year, Paper
Question
diagram, explain why a
firm in perfect competition
might only be able to make
supernormal (abnormal)
profits in the short-run and
not in the long-run. [10
marks]
Student Outline Response





a definition of supernormal (abnormal) profits
an explanation of supernormal (abnormal) profits
an explanation of perfect competition
a standard short-run perfect competition diagram showing
supernormal (abnormal) profit at profit maximizing output
an explanation of short-run supernormal (abnormal) profit
leading to entry of new firms into the industry, the market supply
curve shifting right, price falling and the supernormal (abnormal)
profits being eliminated (until only normal profits are made).
Answers may include:

a distinction between the short-run and long-run in
microeconomics

diagrams to illustrate the last bullet point above

an explanation of why short-run abnormal profit is made.
PC
PC & M
2007 November P2
2009 May P1
2. With the help of a
diagram, explain when a
firm should shut down in
the short run.
(b) Evaluate the view that
greater economic efficiency
will always be achieved in
perfect competition as
compared to monopoly.
[15 marks]
Answers may include:





definition of short run
explanation that the aim of the firm is profit maximization
profits maximized where MC = MR
explanations of abnormal profits and losses
explanation that total costs are the sum of fixed costs and
variable costs

explanation that in the short-run average variable costs must be
covered if the firm is to continue in business

identification of shut down point

diagrammatic representation and explanation

To reach levels 3 and 4 candidates should demonstrate clear
ability to apply relevant theory and/or to analyse using relevant
theory.
Answers may include:

definitions of perfect competition and monopoly

explanation of economic efficiency in terms of allocative and productive
efficiency (and possibly dynamic efficiency)

explanation of achievement of allocative efficiency (P = MC) in perfect
competition

diagram illustrating the above explanation of achievement of productive
efficiency (AC = MC),

operating at the minimum AC diagram illustrating the above explanation of
allocative inefficiency (P greater than MC) in monopoly diagram illustrating
the above explanation of productive inefficiency in monopoly (not operating
with minimum AC)

diagram illustrating the above possibility of economies of scale in monopoly
and therefore lower costs and prices possibility of long-run dynamic
efficiency in monopoly abnormal profits in monopoly provide funds for
research and development importance of externalities for efficiency
8
Syllabus
Year, Paper
Question
PC & MC
2010 November P2
2. Using a diagram(s),
explain how the
characteristics/assumptions
of the models of perfect
competition
and monopolistic
competition result in
different demand curves
for individual firms.
PC & MC
2007 November P1
1. (b) “Perfect competition
is a more desirable market
form than monopolistic
competition.” Discuss. [15
marks]
Student Outline Response
reference to the case of natural monopoly.
Effective evaluation may be to: consider short-term versus long-term consequences
examine the impact on different stakeholders prioritize the arguments.
Candidates may include the following:

an explanation of characteristics/assumptions of perfect
competition an explanation of characteristics/assumptions of
monopolistic competition an explanation of why the demand
curve for the firm in perfect competition is perfectly elastic

a diagram showing the above an explanation of why the demand
curve for the firm in monopolistic competition is downward
sloping

a diagram showing the above examples of markets which
approximate perfect competition and monopolistic competition.
Examiners should be aware that candidates may take a different
approach which if appropriate, should be rewarded.
Candidates may compare the assumptions of perfect competition with
those of monopolistic competition. Candidates may discuss the
advantages and disadvantages of perfect competition and compare them
to monopolistic competition. Advantages of perfect competition may
include:

allocative and productive efficiency

consumer gains from low prices

consumer sovereignty.
Disadvantages of perfect competition may include:

firms unable to invest in research and development due to lack of
abnormal/ supernormal profits

lack of choice of products.
Advantages of monopolistic competition may include:

possible economies of scale to be gained

consumer benefits from greater variety of products to choose
from

non-price competition leads to product development and
advertising.
Disadvantages of monopolistic competition may include:

higher price and lower output than under perfect competition

firms do not produce at the least-cost point

less efficient allocation of resources than in perfect competition.
Examiners should be aware that candidates may take a different
approach, which if appropriate should be rewarded. Effective evaluation
may be to:
consider short run versus long run consequences
9
Syllabus
Year, Paper
Question
Student Outline Response
examine the impact on different stakeholders
discuss advantages and disadvantages
prioritize the arguments
PC & O
2011 May P1
1. (b) Evaluate the view
that perfect competition is
a more desirable market
form than oligopoly. [15
marks]
Answers may include:

an explanation of the difference between perfect competition and
oligopoly

perfect competition and oligopoly diagrams
an explanation of the term “desirable” (stakeholder approach)
comparison in terms of:
– productive efficiency
– allocative efficiency
– short-run and long-run efficiency
– economies of scale
– price, output and profits
– consumer choice
– impact of product differentiation/non-price competition
– freedom of entry to the markets
– the ability/lack of ability to price discriminate
assessment of which market form is most desirable.
Effective evaluation may be to:

consider short-term versus long-term consequences

examine the impact on different stakeholders

discuss advantages and disadvantages

prioritize the arguments.
SR & LR
2009 May P1
1. (a) In the theory of the
firm, a distinction is made
between short-run cost
curves and long-run cost
curves. Using appropriate
cost curve diagrams,
explain this distinction. [10
marks]
Answers should include: definitions of short-run and long-run U shaped
SRAC diagram diagram showing LRAC as L-shaped and/or U-shaped.
N.B. Candidates may also include the SRMC diagram. This should be
rewarded but is not necessary to achieve full marks.
Answers may include: explanation of SRAC in terms of the law of
diminishing returns explanation of the LRAC in terms of
economies/diseconomies of scale.
A clear distinction between SRAC and LRAC must appear in the answer,
for example, in terms of diminishing returns and diseconomies/economies
of scale to achieve level 4.
10