Chapter 4
Teacher notes
Concentrated markets: theory of
monopoly
Activity, page 42.
1 “Barriers to entry” refers to anything that may prevent a new firm from entering a particular
industry. They can be ‘natural’ i.e. where the incumbent firm has also faced the same problem when
it started up the industry (e.g. extremely high initial set-up costs), or ‘artificial’ i.e. where the
incumbent firm creates a barrier once it is in the industry (e.g. using expensive
advertising/marketing).
2
3 Students should choose two or three barriers to entry, and give a definition and an example of each,
e.g.
a) Patent laws: this is a barrier to entry because the existence of a patent prevents any other
company from using a particular design. Examples could include Dyson’s vacuum cleaner,
Microsoft’s operating system Windows and so on
b) Nationalised industry/sole licence to operate: this is a barrier to entry because it is illegal for
another firm to join the industry. Examples could include the Post Office’s small letter delivery
service, Air Traffic Control, British Nuclear Fuel
c) Geography: the pipeline network of utility companies (gas, water, electricity) is a good example
Activity, page 43.
4 A natural monopoly exists when it simply doesn’t make economic sense, and would be less
efficient, to have more than one company supplying the market.
5 Conditions under which natural monopoly exist include:
a) Extremely high initial set-up, or sunk, costs
b) Economies of scale only occur once an extremely high level of output is produced i.e. the
minimum efficient scale is high
6 Arguments in favour of Network Rail being a natural monopoly include:
a) It is expensive to purchase land on which to build a railway and ensure that it is suitable (i.e. flat,
no possibility of subsidence etc), therefore high sunk costs
b) It is expensive to install the physical railway and railway stations, and maintain it, therefore
another example of high sunk costs
c) It simply doesn’t make sense for there to be a number of rail networks in one area, as this would
use much more land, and consumers might get confused as to how they would cross from one
network to another
Arguments against Network Rail being a natural monopoly include:
AQA Economics A2 © Nelson Thornes Ltd 2009
1
Chapter 4
Teacher notes
d) It is unclear, apart from bulk-buying, how Network Rail could benefit from economies of scale –
because of their size, it seems perhaps more likely that they achieve diseconomies of scale (poor
communication leading to poor maintenance records and accidents, low morale of workers as
shown by strike action etc)
Activity, page 44.
7
8 The imposition of a unit will shift the supply curve up and to the left, thus raising the market price
and reducing consumer surplus.
9 Perfectly elastic demand curve: consumer surplus falls, producer surplus likely to stay the same.
Perfectly inelastic demand curve: consumer surplus falls, producer surplus may actually increase.
This really depends on how elastic/inelastic the demand curves are drawn.
Activity, page 49.
10 Firms may want to price discriminate because it allows them to ‘appropriate’ consumer surplus i.e.
convert consumer surplus into producer surplus/profit.
11 The conditions under which price discrimination can occur are:
a) The producer is a ‘price-maker’ and therefore has control over prices/output (i.e. some degree of
market/monopoly power)
b) Consumers are not able to sell the products to each other i.e. there is no chance of arbitrage
c) Different consumers have different price elasticities of demand, which means that they will be
willing to pay different prices
12 Analysis: ways in which a train operating company can price discriminate include:
a) By age – children, students, adults and pensioners all pay different fares (3rd degree
discrimination) - adults are assumed to have a more inelastic PED
i)BUT – not all adults have an inelastic PED (e.g. low income), and not all children/students
have an elastic PED
b) By time – peak travel tickets are more expensive than off-peak (3rd degree discrimination) –
peak travellers are assumed to have a more inelastic PED
i)
BUT – many people, such as schoolchildren or students, have to travel at peak times
because of the timing of the school day, even though they may not be able to afford it
c) Date of purchase – tickets bought in advance are often cheaper than tickets bought on the day of
travel (3rd degree discrimination)
i)BUT – it can be difficult for consumers to know when the cheaper tickets become available as
‘supersaver’ fares can usually only be bought from 14 days in advance of travel and not any
earlier, and different train operating companies have different advance purchase policies
d) Group purchases – group tickets work out cheaper per person than buying separate tickets (2nd
degree discrimination)
AQA Economics A2 © Nelson Thornes Ltd 2009
2
Chapter 4
Teacher notes
BUT – there is usually a minimum group size and tickets often have to be bought in
advance
e) Bundling – tickets often provide discount entry to attractions e.g. using South West Trains to
travel to Windsor allows discounted entry to Legoland (complex price discrimination)
f) Note – first class is more expensive than standard class but consumers aren’t getting the same
product. first class passengers have bigger seats so this isn’t really price discrimination which is
where different consumers pay different prices for identical products
Arbitrage is prevented in many cases by the use of electronic barriers which prevent off-peak ticket
holders from travelling at peak times, and photo ID for students/children/frequent passengers.
Further evaluation:
i) there are a huge number of possible fares available to travellers on the railway network,
which makes it confusing, and there is often a big difference between peak/off peak fares
which makes it difficult for marginal consumers to choose their preferred travel time.
ii) The large number of train operating companies across the country makes it even more
difficult for consumers to know that they are paying the most appropriate fare.
iii) If the TOCs reinvest the increased profit then services may improve for travellers (although
they have had problems for years with overcrowding and dirty trains, suggesting that profits
are not high enough even with the use of price discrimination)
i)
AQA Examination-style questions, page 51.
Data response question 1:
a) Students should comment about the percentage of profits which are earned in the UK which is
shown in both diagrams. They may also have commented on the fact that profits in Latin America
are negative. Certain conclusions could be drawn – that the UK is being exploited or profits are
negative in LA as vast amounts of investment are taking place which may increase sales and
profitability for the future.
b)
Students might:
 draw the conclusion using the diagram on page 44 that a monopoly might charge a price QMI for
the last unit QM in excess of the marginal cost QMJ which would not be allocatively efficient
 explain that supernormal profits may be made, diagram on page 40 of £20 per unit for 20 units
suggesting that more competition is required
 explain that a deadweight loss occurs under monopoly, diagram on page 44 of KGJ as factors are
not fully utilised
 explain that some consumers are excluded from the market who would have been able to purchase
under competitive conditions, page 44 QM-QC
AQA Economics A2 © Nelson Thornes Ltd 2009
3
Chapter 4
Teacher notes

explain that the monopolist appropriates some of the consumer surplus which under perfect
competition would have been FEG, page 44 and has fallen to HEI
 use the diagram on page to 40 explain why the monopolist is not productively efficient as it does
not produce at the lowest possible cost – at the lowest point of the ATC.
c) Define types of efficiency, including productive, allocative, Pareto, x, and dynamic.
The monopoly diagram drawn for Question 2 could be marked with the productively efficient point
(lowest AC) and the allocatively efficient point (AR = MC), thus demonstrating that under
monopoly, these types of efficiency are not achieved. X-inefficiency is also assumed to exist under
monopoly.
Evaluation:
i) monopolists may be dynamically efficient as they earn supernormal profits which may be
reinvested in the company, through R&D for example.
ii) Monopolists tend to be large companies, and may therefore benefit from economies of scale,
allowing them to reduce their average costs below the level that would be achieved in a more
competitive market structure
iii) Water supply tends to fit into the bracket of ‘natural monopoly’, which means that it makes no
economic sense to have more than one company supplying the market in a particular
geographical area, therefore the outcome of monopoly is as efficient as it can be
Essay question 2:
Define monopoly
Draw the monopoly diagram, showing high price/low output (therefore loss of consumer
surplus) and supernormal profit (could also show the deadweight loss associated with
monopoly)
Explain that the monopoly outcome is neither productively nor allocatively efficient, and
may be x-inefficient – therefore undesirable
AQA Economics A2 © Nelson Thornes Ltd 2009
4