IB · ECON HL

Economics HL

Microeconomics HL: market structures — Unit 2 HL

Name: ____________________Date: October 2, 2026

1.
A perfectly competitive firm faces a market price of $15 per unit. Its total cost function is TC = Q² + 2Q + 10, giving a marginal cost of MC = 2Q + 2. (a) Calculate the profit-maximizing output level, where P = MC. (b) Calculate the firm's total revenue, total cost, and profit at this output.
[5 marks]
Marking points
- Sets P = MC: 15 = 2Q + 2.
- Solves to obtain Q = 6.5 units.
- Calculates total revenue as P × Q = 15 × 6.5 = $97.50.
- Calculates total cost as 6.5² + 2(6.5) + 10 = $65.25.
- Calculates profit as TR − TC = 97.50 − 65.25 = $32.25.
Examiner tip: A perfectly competitive firm is a price taker, so it always maximizes profit by producing where its own marginal cost equals the given market price — it never has to choose a price.
2.
Marking analysis: A learner attempts the following task: “A perfectly competitive firm faces a market price of $15 per unit. Its total cost function is TC = Q² + 2Q + 10, giving a marginal cost of MC = 2Q + 2. (a) Calculate the profit-maximizing output level, where P = MC. (b) Calculate the firm's total revenue, total cost, and profit at this output.” Their response addresses only this point: “Sets P = MC: 15 = 2Q + 2.” Evaluate the response against the complete 5-mark task. Identify what earns credit and state every additional requirement needed for full marks.
[5 marks]
Marking points
- Recognises credit for the stated point: Sets P = MC: 15 = 2Q + 2.
- Identifies the missing requirement: Solves to obtain Q = 6.5 units.
- Identifies the missing requirement: Calculates total revenue as P × Q = 15 × 6.5 = $97.50.
- Identifies the missing requirement: Calculates total cost as 6.5² + 2(6.5) + 10 = $65.25.
- Identifies the missing requirement: Calculates profit as TR − TC = 97.50 − 65.25 = $32.25.
Examiner tip: Treat each marking point as a separate requirement. Do not award the same idea twice, and do not infer work the learner did not show.
3.
Explain why a perfectly competitive firm can earn supernormal profit in the short run but only normal profit in the long run.
[3 marks] · no calculator
Marking points
- States that if existing firms are earning supernormal profit in the short run, this acts as a signal attracting new firms to enter the industry, since there are no significant barriers to entry.
- Explains that as new firms enter, market supply increases, shifting the market supply curve to the right and lowering the market price.
- Explains that entry continues until the price falls to the level of each firm's minimum average cost, at which point supernormal profit is competed away and only normal profit remains, removing any further incentive to enter.
Examiner tip: Free entry and exit is the key assumption driving this result — it is precisely why perfect competition cannot sustain supernormal profit in the long run, unlike monopoly.
4.
Marking analysis: A learner attempts the following task: “Explain why a perfectly competitive firm can earn supernormal profit in the short run but only normal profit in the long run.” Their response addresses only this point: “States that if existing firms are earning supernormal profit in the short run, this acts as a signal attracting new firms to enter the industry, since there are no significant barriers to entry.” Evaluate the response against the complete 3-mark task. Identify what earns credit and state every additional requirement needed for full marks.
[3 marks] · no calculator
Marking points
- Recognises credit for the stated point: States that if existing firms are earning supernormal profit in the short run, this acts as a signal attracting new firms to enter the industry, since there are no significant barriers to entry.
- Identifies the missing requirement: Explains that as new firms enter, market supply increases, shifting the market supply curve to the right and lowering the market price.
- Identifies the missing requirement: Explains that entry continues until the price falls to the level of each firm's minimum average cost, at which point supernormal profit is competed away and only normal profit remains, removing any further incentive to enter.
Examiner tip: Treat each marking point as a separate requirement. Do not award the same idea twice, and do not infer work the learner did not show.
5.
A monopolist faces demand P = 100 − 2Q and has a constant marginal cost of MC = 20. (a) Derive the marginal revenue function. (b) Calculate the profit-maximizing output and price, where MR = MC. (c) Calculate the monopolist's profit, assuming no fixed costs.
[5 marks]
Marking points
- States total revenue TR = PQ = (100 − 2Q)Q = 100Q − 2Q².
- Differentiates to obtain MR = 100 − 4Q.
- Sets MR = MC: 100 − 4Q = 20, and solves to obtain Q = 20.
- Substitutes Q = 20 into the demand equation to obtain P = 100 − 2(20) = $60.
- Calculates profit as (P − MC) × Q = (60 − 20) × 20 = $800.
Examiner tip: The monopolist's marginal revenue curve always has twice the slope of a linear demand curve — notice that MR = 100 − 4Q falls twice as fast as the demand curve P = 100 − 2Q.
6.
Marking analysis: A learner attempts the following task: “A monopolist faces demand P = 100 − 2Q and has a constant marginal cost of MC = 20. (a) Derive the marginal revenue function. (b) Calculate the profit-maximizing output and price, where MR = MC. (c) Calculate the monopolist's profit, assuming no fixed costs.” Their response addresses only this point: “States total revenue TR = PQ = (100 − 2Q)Q = 100Q − 2Q².” Evaluate the response against the complete 5-mark task. Identify what earns credit and state every additional requirement needed for full marks.
[5 marks]
Marking points
- Recognises credit for the stated point: States total revenue TR = PQ = (100 − 2Q)Q = 100Q − 2Q².
- Identifies the missing requirement: Differentiates to obtain MR = 100 − 4Q.
- Identifies the missing requirement: Sets MR = MC: 100 − 4Q = 20, and solves to obtain Q = 20.
- Identifies the missing requirement: Substitutes Q = 20 into the demand equation to obtain P = 100 − 2(20) = $60.
- Identifies the missing requirement: Calculates profit as (P − MC) × Q = (60 − 20) × 20 = $800.
Examiner tip: Treat each marking point as a separate requirement. Do not award the same idea twice, and do not infer work the learner did not show.
7.
Using the monopoly from the previous question (demand P = 100 − 2Q, MC = 20), explain why the monopoly outcome (Q = 20, P = 60) is allocatively inefficient compared to a perfectly competitive outcome in the same market.
[4 marks] · no calculator
Marking points
- States that allocative efficiency requires price to equal marginal cost (P = MC).
- Calculates that under perfect competition, P = MC would give 100 − 2Q = 20, so Q = 40 and P = $20 — a higher output and lower price than under monopoly.
- Explains that the monopolist restricts output below this competitive level (Q = 20 instead of 40) and charges a price above marginal cost (P = 60 versus MC = 20) in order to maximize its own profit.
- Concludes that this restriction creates a deadweight welfare loss, since some consumers who valued the good above its marginal cost of production are excluded from the market.
Examiner tip: Reusing the same demand and cost functions to compare monopoly and perfect competition outcomes directly is a classic HL technique — it lets you quantify exactly how much output is 'missing' and why.
8.
Marking analysis: A learner attempts the following task: “Using the monopoly from the previous question (demand P = 100 − 2Q, MC = 20), explain why the monopoly outcome (Q = 20, P = 60) is allocatively inefficient compared to a perfectly competitive outcome in the same market.” Their response addresses only this point: “States that allocative efficiency requires price to equal marginal cost (P = MC).” Evaluate the response against the complete 4-mark task. Identify what earns credit and state every additional requirement needed for full marks.
[4 marks] · no calculator
Marking points
- Recognises credit for the stated point: States that allocative efficiency requires price to equal marginal cost (P = MC).
- Identifies the missing requirement: Calculates that under perfect competition, P = MC would give 100 − 2Q = 20, so Q = 40 and P = $20 — a higher output and lower price than under monopoly.
- Identifies the missing requirement: Explains that the monopolist restricts output below this competitive level (Q = 20 instead of 40) and charges a price above marginal cost (P = 60 versus MC = 20) in order to maximize its own profit.
- Identifies the missing requirement: Concludes that this restriction creates a deadweight welfare loss, since some consumers who valued the good above its marginal cost of production are excluded from the market.
Examiner tip: Treat each marking point as a separate requirement. Do not award the same idea twice, and do not infer work the learner did not show.
9.
A firm with market power sells in two separate markets it can keep apart: Market A, with demand P = 50 − Q, and Market B, with demand P = 80 − 2Q. The firm has a constant marginal cost of $10 in both markets. (a) Calculate the profit-maximizing price and quantity in each market. (b) Calculate the firm's total profit from price discrimination.
[5 marks]
Marking points
- Derives MR_A = 50 − 2Q_A and sets MR_A = MC: 50 − 2Q_A = 10, giving Q_A = 20 and P_A = 50 − 20 = $30.
- Derives MR_B = 80 − 4Q_B and sets MR_B = MC: 80 − 4Q_B = 10, giving Q_B = 17.5 and P_B = 80 − 2(17.5) = $45.
- Notes that the firm charges a higher price in Market B, the market with the less elastic demand at the chosen price.
- Calculates profit in Market A as (30 − 10) × 20 = $400, and profit in Market B as (45 − 10) × 17.5 = $612.50.
- Calculates total profit as 400 + 612.50 = $1,012.50.
Examiner tip: Third-degree price discrimination always sets a separate MR = MC condition in each market — solve each market completely independently before combining the results into a total profit.
10.
Marking analysis: A learner attempts the following task: “A firm with market power sells in two separate markets it can keep apart: Market A, with demand P = 50 − Q, and Market B, with demand P = 80 − 2Q. The firm has a constant marginal cost of $10 in both markets. (a) Calculate the profit-maximizing price and quantity in each market. (b) Calculate the firm's total profit from price discrimination.” Their response addresses only this point: “Derives MR_A = 50 − 2Q_A and sets MR_A = MC: 50 − 2Q_A = 10, giving Q_A = 20 and P_A = 50 − 20 = $30.” Evaluate the response against the complete 5-mark task. Identify what earns credit and state every additional requirement needed for full marks.
[5 marks]
Marking points
- Recognises credit for the stated point: Derives MR_A = 50 − 2Q_A and sets MR_A = MC: 50 − 2Q_A = 10, giving Q_A = 20 and P_A = 50 − 20 = $30.
- Identifies the missing requirement: Derives MR_B = 80 − 4Q_B and sets MR_B = MC: 80 − 4Q_B = 10, giving Q_B = 17.5 and P_B = 80 − 2(17.5) = $45.
- Identifies the missing requirement: Notes that the firm charges a higher price in Market B, the market with the less elastic demand at the chosen price.
- Identifies the missing requirement: Calculates profit in Market A as (30 − 10) × 20 = $400, and profit in Market B as (45 − 10) × 17.5 = $612.50.
- Identifies the missing requirement: Calculates total profit as 400 + 612.50 = $1,012.50.
Examiner tip: Treat each marking point as a separate requirement. Do not award the same idea twice, and do not infer work the learner did not show.
11.
State three conditions that must hold for a firm to be able to successfully practice price discrimination.
[3 marks] · no calculator
Marking points
- States that the firm must have some degree of market/monopoly power (the ability to set price above marginal cost).
- States that the firm must be able to separate consumers into distinct groups, usually with different price elasticities of demand.
- States that the firm must be able to prevent resale (arbitrage) between the groups, so that consumers who bought at the lower price cannot resell to consumers facing the higher price.
Examiner tip: If resale between groups cannot be prevented, price discrimination collapses: buyers in the low-price market would simply resell to buyers in the high-price market, eliminating the price gap.
12.
Marking analysis: A learner attempts the following task: “State three conditions that must hold for a firm to be able to successfully practice price discrimination.” Their response addresses only this point: “States that the firm must have some degree of market/monopoly power (the ability to set price above marginal cost).” Evaluate the response against the complete 3-mark task. Identify what earns credit and state every additional requirement needed for full marks.
[3 marks] · no calculator
Marking points
- Recognises credit for the stated point: States that the firm must have some degree of market/monopoly power (the ability to set price above marginal cost).
- Identifies the missing requirement: States that the firm must be able to separate consumers into distinct groups, usually with different price elasticities of demand.
- Identifies the missing requirement: States that the firm must be able to prevent resale (arbitrage) between the groups, so that consumers who bought at the lower price cannot resell to consumers facing the higher price.
Examiner tip: Treat each marking point as a separate requirement. Do not award the same idea twice, and do not infer work the learner did not show.
13.
Explain why a monopolistically competitive firm can earn supernormal profit in the short run but typically earns only normal profit in the long run, despite being able to differentiate its product.
[4 marks] · no calculator
Marking points
- States that monopolistically competitive markets have low barriers to entry, similar to perfect competition.
- Explains that short-run supernormal profit attracts new firms offering similar (but differentiated) products, increasing competition faced by the original firm.
- Explains that as firms enter, each existing firm's demand curve shifts left (and becomes more elastic) as consumers have more substitute brands to choose from, reducing each firm's market share and price.
- Concludes that entry continues until price falls to equal average cost, leaving only normal profit, even though each firm retains some limited pricing power from product differentiation.
Examiner tip: The key difference from perfect competition is that the monopolistically competitive firm's long-run equilibrium occurs where price equals average cost but is still above marginal cost, since the demand curve it faces is downward sloping, not horizontal.
14.
Marking analysis: A learner attempts the following task: “Explain why a monopolistically competitive firm can earn supernormal profit in the short run but typically earns only normal profit in the long run, despite being able to differentiate its product.” Their response addresses only this point: “States that monopolistically competitive markets have low barriers to entry, similar to perfect competition.” Evaluate the response against the complete 4-mark task. Identify what earns credit and state every additional requirement needed for full marks.
[4 marks] · no calculator
Marking points
- Recognises credit for the stated point: States that monopolistically competitive markets have low barriers to entry, similar to perfect competition.
- Identifies the missing requirement: Explains that short-run supernormal profit attracts new firms offering similar (but differentiated) products, increasing competition faced by the original firm.
- Identifies the missing requirement: Explains that as firms enter, each existing firm's demand curve shifts left (and becomes more elastic) as consumers have more substitute brands to choose from, reducing each firm's market share and price.
- Identifies the missing requirement: Concludes that entry continues until price falls to equal average cost, leaving only normal profit, even though each firm retains some limited pricing power from product differentiation.
Examiner tip: Treat each marking point as a separate requirement. Do not award the same idea twice, and do not infer work the learner did not show.
15.
Explain the kinked demand curve model of oligopoly, and describe why it predicts that oligopolists are reluctant to change their prices.
[3 marks] · no calculator
Marking points
- States that the kinked demand curve assumes rival firms will match a price cut (to avoid losing market share) but will not match a price increase (to gain market share from the firm that raised its price).
- Explains that this creates a relatively elastic demand curve above the current price (since a price rise is not matched, causing a large loss of customers) and a relatively inelastic demand curve below it (since a price cut is matched, so little is gained in market share).
- Explains that this kink creates a discontinuity (vertical gap) in the marginal revenue curve, meaning marginal cost can shift within this gap without changing the profit-maximizing price, explaining observed price rigidity (price stickiness) in oligopolistic markets.
Examiner tip: The kinked demand curve model explains price rigidity, but it does not explain how the initial price was set in the first place — it only describes why, once set, oligopolists resist changing it.
16.
Marking analysis: A learner attempts the following task: “Explain the kinked demand curve model of oligopoly, and describe why it predicts that oligopolists are reluctant to change their prices.” Their response addresses only this point: “States that the kinked demand curve assumes rival firms will match a price cut (to avoid losing market share) but will not match a price increase (to gain market share from the firm that raised its price).” Evaluate the response against the complete 3-mark task. Identify what earns credit and state every additional requirement needed for full marks.
[3 marks] · no calculator
Marking points
- Recognises credit for the stated point: States that the kinked demand curve assumes rival firms will match a price cut (to avoid losing market share) but will not match a price increase (to gain market share from the firm that raised its price).
- Identifies the missing requirement: Explains that this creates a relatively elastic demand curve above the current price (since a price rise is not matched, causing a large loss of customers) and a relatively inelastic demand curve below it (since a price cut is matched, so little is gained in market share).
- Identifies the missing requirement: Explains that this kink creates a discontinuity (vertical gap) in the marginal revenue curve, meaning marginal cost can shift within this gap without changing the profit-maximizing price, explaining observed price rigidity (price stickiness) in oligopolistic markets.
Examiner tip: Treat each marking point as a separate requirement. Do not award the same idea twice, and do not infer work the learner did not show.
17.
Two oligopolists, Firm X and Firm Y, must each simultaneously decide whether to 'Advertise' or 'Not Advertise'. The payoff matrix below shows (Firm X profit, Firm Y profit) in millions of dollars for each combination of strategies: {Both Advertise: (20, 20); X Advertises, Y Does Not: (40, 10); X Does Not, Y Advertises: (10, 40); Neither Advertises: (30, 30)}. (a) Identify Firm X's dominant strategy, if one exists. (b) Identify the Nash equilibrium of this game. (c) Explain why the Nash equilibrium outcome may not be the best outcome for both firms jointly.
[4 marks] · no calculator
Marking points
- Checks Firm X's best response to each of Y's choices: if Y advertises, X earns more by advertising (20 > 10); if Y does not advertise, X still earns more by advertising (40 > 30).
- Identifies 'Advertise' as Firm X's dominant strategy, since it is the best choice regardless of what Firm Y does (and by symmetry, the same applies to Firm Y).
- Identifies the Nash equilibrium as (Advertise, Advertise), with payoffs (20, 20), since neither firm can improve its own payoff by unilaterally changing its strategy.
- Explains that if both firms instead cooperated and chose 'Not Advertise', both would earn a higher payoff (30, 30), but this outcome is unstable because each firm has an individual incentive to deviate and advertise, undercutting the other.
Examiner tip: This payoff structure is a classic prisoner's dilemma: the individually rational dominant strategy for each player leads to a jointly worse outcome than mutual cooperation would achieve.
18.
Marking analysis: A learner attempts the following task: “Two oligopolists, Firm X and Firm Y, must each simultaneously decide whether to 'Advertise' or 'Not Advertise'. The payoff matrix below shows (Firm X profit, Firm Y profit) in millions of dollars for each combination of strategies: {Both Advertise: (20, 20); X Advertises, Y Does Not: (40, 10); X Does Not, Y Advertises: (10, 40); Neither Advertises: (30, 30)}. (a) Identify Firm X's dominant strategy, if one exists. (b) Identify the Nash equilibrium of this game. (c) Explain why the Nash equilibrium outcome may not be the best outcome for both firms jointly.” Their response addresses only this point: “Checks Firm X's best response to each of Y's choices: if Y advertises, X earns more by advertising (20 > 10); if Y does not advertise, X still earns more by advertising (40 > 30).” Evaluate the response against the complete 4-mark task. Identify what earns credit and state every additional requirement needed for full marks.
[4 marks] · no calculator
Marking points
- Recognises credit for the stated point: Checks Firm X's best response to each of Y's choices: if Y advertises, X earns more by advertising (20 > 10); if Y does not advertise, X still earns more by advertising (40 > 30).
- Identifies the missing requirement: Identifies 'Advertise' as Firm X's dominant strategy, since it is the best choice regardless of what Firm Y does (and by symmetry, the same applies to Firm Y).
- Identifies the missing requirement: Identifies the Nash equilibrium as (Advertise, Advertise), with payoffs (20, 20), since neither firm can improve its own payoff by unilaterally changing its strategy.
- Identifies the missing requirement: Explains that if both firms instead cooperated and chose 'Not Advertise', both would earn a higher payoff (30, 30), but this outcome is unstable because each firm has an individual incentive to deviate and advertise, undercutting the other.
Examiner tip: Treat each marking point as a separate requirement. Do not award the same idea twice, and do not infer work the learner did not show.
19.
Explain why firms in a cartel (collusive oligopoly) each have an individual incentive to secretly break the agreement, even though the cartel as a whole is more profitable if all members cooperate.
[4 marks] · no calculator
Marking points
- States that a cartel typically restricts total output and agrees on a higher, monopoly-like price to maximize joint industry profit.
- Explains that at this high agreed price, any single member could individually increase its own profit by secretly producing and selling more than its agreed quota, since the price is well above its own marginal cost.
- Explains that if enough members cheat in this way, total output rises and the market price falls, eventually breaking down the cartel agreement entirely.
- Concludes that this tension between collective and individual incentives makes cartels inherently unstable without an effective enforcement mechanism.
Examiner tip: OPEC is the classic real-world example examiners expect: even with a formal agreement on output quotas, member countries have repeatedly been found to exceed their quotas when the price is high enough to make cheating individually profitable.
20.
Marking analysis: A learner attempts the following task: “Explain why firms in a cartel (collusive oligopoly) each have an individual incentive to secretly break the agreement, even though the cartel as a whole is more profitable if all members cooperate.” Their response addresses only this point: “States that a cartel typically restricts total output and agrees on a higher, monopoly-like price to maximize joint industry profit.” Evaluate the response against the complete 4-mark task. Identify what earns credit and state every additional requirement needed for full marks.
[4 marks] · no calculator
Marking points
- Recognises credit for the stated point: States that a cartel typically restricts total output and agrees on a higher, monopoly-like price to maximize joint industry profit.
- Identifies the missing requirement: Explains that at this high agreed price, any single member could individually increase its own profit by secretly producing and selling more than its agreed quota, since the price is well above its own marginal cost.
- Identifies the missing requirement: Explains that if enough members cheat in this way, total output rises and the market price falls, eventually breaking down the cartel agreement entirely.
- Identifies the missing requirement: Concludes that this tension between collective and individual incentives makes cartels inherently unstable without an effective enforcement mechanism.
Examiner tip: Treat each marking point as a separate requirement. Do not award the same idea twice, and do not infer work the learner did not show.
21.
Explain why a natural monopoly arises in an industry with very high fixed costs and declining long-run average costs over a large range of output, using the example of water supply infrastructure.
[3 marks] · no calculator
Marking points
- States that building the water pipe network involves an extremely large fixed cost, which is spread over more and more units of water supplied as output increases.
- Explains that this causes long-run average cost to fall continuously (economies of scale) over a very large range of output, often large enough to cover the entire market demand.
- Concludes that a single large firm can therefore supply the entire market at a lower average cost than two or more smaller firms each duplicating the fixed infrastructure, making a single-firm (monopoly) market structure the most cost-efficient outcome.
Examiner tip: Natural monopoly is the one case where a single firm is genuinely the most efficient market structure — the policy problem then becomes how to prevent that firm from abusing its market power, not how to introduce competition.
22.
Marking analysis: A learner attempts the following task: “Explain why a natural monopoly arises in an industry with very high fixed costs and declining long-run average costs over a large range of output, using the example of water supply infrastructure.” Their response addresses only this point: “States that building the water pipe network involves an extremely large fixed cost, which is spread over more and more units of water supplied as output increases.” Evaluate the response against the complete 3-mark task. Identify what earns credit and state every additional requirement needed for full marks.
[3 marks] · no calculator
Marking points
- Recognises credit for the stated point: States that building the water pipe network involves an extremely large fixed cost, which is spread over more and more units of water supplied as output increases.
- Identifies the missing requirement: Explains that this causes long-run average cost to fall continuously (economies of scale) over a very large range of output, often large enough to cover the entire market demand.
- Identifies the missing requirement: Concludes that a single large firm can therefore supply the entire market at a lower average cost than two or more smaller firms each duplicating the fixed infrastructure, making a single-firm (monopoly) market structure the most cost-efficient outcome.
Examiner tip: Treat each marking point as a separate requirement. Do not award the same idea twice, and do not infer work the learner did not show.
23.
Using the monopoly from an earlier question (demand P = 100 − 2Q, constant MC = 20), explain what price and quantity a regulator would set under a 'marginal cost pricing' rule, and state one problem this rule can cause for a natural monopoly with high fixed costs.
[3 marks]
Marking points
- States that marginal cost pricing sets price equal to marginal cost: 100 − 2Q = 20.
- Solves to obtain Q = 40 and P = $20, the allocatively efficient outcome.
- States the problem: if the firm has substantial fixed costs, setting price equal to marginal cost (which does not include any contribution to fixed costs) will cause the firm to make a loss, since average cost exceeds price at this output.
Examiner tip: This is exactly why regulators sometimes use 'average cost pricing' instead, setting price equal to average cost (P = AC) — this sacrifices some allocative efficiency but ensures the firm can at least break even without a government subsidy.
24.
Marking analysis: A learner attempts the following task: “Using the monopoly from an earlier question (demand P = 100 − 2Q, constant MC = 20), explain what price and quantity a regulator would set under a 'marginal cost pricing' rule, and state one problem this rule can cause for a natural monopoly with high fixed costs.” Their response addresses only this point: “States that marginal cost pricing sets price equal to marginal cost: 100 − 2Q = 20.” Evaluate the response against the complete 3-mark task. Identify what earns credit and state every additional requirement needed for full marks.
[3 marks]
Marking points
- Recognises credit for the stated point: States that marginal cost pricing sets price equal to marginal cost: 100 − 2Q = 20.
- Identifies the missing requirement: Solves to obtain Q = 40 and P = $20, the allocatively efficient outcome.
- Identifies the missing requirement: States the problem: if the firm has substantial fixed costs, setting price equal to marginal cost (which does not include any contribution to fixed costs) will cause the firm to make a loss, since average cost exceeds price at this output.
Examiner tip: Treat each marking point as a separate requirement. Do not award the same idea twice, and do not infer work the learner did not show.
25.
Explain the concept of a 'contestable market', and state why a market with high barriers to entry and exit cannot be contestable, even if it currently has only one firm operating in it.
[3 marks] · no calculator
Marking points
- Defines a contestable market as one with very low barriers to entry and exit, such that potential competitors could enter quickly if they saw an opportunity for profit, and exit again without significant loss ('hit-and-run' competition).
- Explains that the mere threat of potential entry can discipline even a single existing firm's behavior, forcing it to keep prices close to average cost to deter entry, even without any actual competitors currently present.
- States that high barriers to entry and exit (such as large sunk costs) prevent potential competitors from entering quickly or leaving without loss, removing this competitive discipline and allowing the existing firm to behave more like an unconstrained monopolist.
Examiner tip: Contestability theory shifts the focus from counting the number of firms currently in a market to assessing the ease of entry and exit — a market with one firm can still behave competitively if it is genuinely contestable.
26.
Marking analysis: A learner attempts the following task: “Explain the concept of a 'contestable market', and state why a market with high barriers to entry and exit cannot be contestable, even if it currently has only one firm operating in it.” Their response addresses only this point: “Defines a contestable market as one with very low barriers to entry and exit, such that potential competitors could enter quickly if they saw an opportunity for profit, and exit again without significant loss ('hit-and-run' competition).” Evaluate the response against the complete 3-mark task. Identify what earns credit and state every additional requirement needed for full marks.
[3 marks] · no calculator
Marking points
- Recognises credit for the stated point: Defines a contestable market as one with very low barriers to entry and exit, such that potential competitors could enter quickly if they saw an opportunity for profit, and exit again without significant loss ('hit-and-run' competition).
- Identifies the missing requirement: Explains that the mere threat of potential entry can discipline even a single existing firm's behavior, forcing it to keep prices close to average cost to deter entry, even without any actual competitors currently present.
- Identifies the missing requirement: States that high barriers to entry and exit (such as large sunk costs) prevent potential competitors from entering quickly or leaving without loss, removing this competitive discipline and allowing the existing firm to behave more like an unconstrained monopolist.
Examiner tip: Treat each marking point as a separate requirement. Do not award the same idea twice, and do not infer work the learner did not show.
27.
In an industry with five firms, market shares are 30%, 25%, 20%, 15%, and 10%. Calculate the four-firm concentration ratio for this industry, and state what this value suggests about the level of competition in the industry.
[3 marks]
Marking points
- Identifies the four largest firms' market shares: 30%, 25%, 20%, 15%.
- Sums these shares: 30 + 25 + 20 + 15 = 90%.
- States that a concentration ratio this high (90%) suggests the industry is highly concentrated, consistent with an oligopoly, since a small number of firms control nearly the entire market.
Examiner tip: The n-firm concentration ratio always sums the market shares of the largest n firms — a value close to 100% indicates high concentration (oligopoly or monopoly), while a low value indicates a more fragmented, competitive market.
28.
Marking analysis: A learner attempts the following task: “In an industry with five firms, market shares are 30%, 25%, 20%, 15%, and 10%. Calculate the four-firm concentration ratio for this industry, and state what this value suggests about the level of competition in the industry.” Their response addresses only this point: “Identifies the four largest firms' market shares: 30%, 25%, 20%, 15%.” Evaluate the response against the complete 3-mark task. Identify what earns credit and state every additional requirement needed for full marks.
[3 marks]
Marking points
- Recognises credit for the stated point: Identifies the four largest firms' market shares: 30%, 25%, 20%, 15%.
- Identifies the missing requirement: Sums these shares: 30 + 25 + 20 + 15 = 90%.
- Identifies the missing requirement: States that a concentration ratio this high (90%) suggests the industry is highly concentrated, consistent with an oligopoly, since a small number of firms control nearly the entire market.
Examiner tip: Treat each marking point as a separate requirement. Do not award the same idea twice, and do not infer work the learner did not show.
29.
Explain the 'price leadership' model of oligopoly behavior, in which one dominant firm sets the price and other firms follow.
[3 marks] · no calculator
Marking points
- States that one large, typically lowest-cost firm in the industry (the price leader) sets its profit-maximizing price.
- Explains that smaller rival firms, recognizing that competing on price against the dominant firm would be unprofitable or risky, choose to match (follow) the leader's price rather than compete directly.
- Explains that this behavior allows the industry to reach a stable, coordinated price without any explicit collusive agreement, which can make it harder for competition authorities to prove anti-competitive behavior.
Examiner tip: Price leadership is an example of 'tacit' (implicit) collusion — firms reach a coordinated outcome through mutual observation and rational self-interest, without any formal agreement that could be legally challenged as a cartel.
30.
Marking analysis: A learner attempts the following task: “Explain the 'price leadership' model of oligopoly behavior, in which one dominant firm sets the price and other firms follow.” Their response addresses only this point: “States that one large, typically lowest-cost firm in the industry (the price leader) sets its profit-maximizing price.” Evaluate the response against the complete 3-mark task. Identify what earns credit and state every additional requirement needed for full marks.
[3 marks] · no calculator
Marking points
- Recognises credit for the stated point: States that one large, typically lowest-cost firm in the industry (the price leader) sets its profit-maximizing price.
- Identifies the missing requirement: Explains that smaller rival firms, recognizing that competing on price against the dominant firm would be unprofitable or risky, choose to match (follow) the leader's price rather than compete directly.
- Identifies the missing requirement: Explains that this behavior allows the industry to reach a stable, coordinated price without any explicit collusive agreement, which can make it harder for competition authorities to prove anti-competitive behavior.
Examiner tip: Treat each marking point as a separate requirement. Do not award the same idea twice, and do not infer work the learner did not show.
31.
Explain why high barriers to entry, such as very large start-up capital requirements or exclusive access to a key resource, allow a monopoly to persist in earning supernormal profit in the long run, unlike firms in perfect competition.
[3 marks] · no calculator
Marking points
- States that supernormal profit in a competitive market normally attracts new entrants, which increases supply and competes the profit away over time.
- Explains that high barriers to entry (such as prohibitive start-up costs, patents, or exclusive control of a key input) prevent potential competitors from entering, even when they observe the monopolist earning high profits.
- Concludes that without this competitive pressure, the monopolist can continue earning supernormal profit indefinitely, in contrast to the perfectly competitive firm whose profit is eroded by free entry.
Examiner tip: Barriers to entry are the single most important structural difference between monopoly and perfect competition — every other difference in pricing and profit outcomes ultimately traces back to whether entry is free or blocked.
32.
Marking analysis: A learner attempts the following task: “Explain why high barriers to entry, such as very large start-up capital requirements or exclusive access to a key resource, allow a monopoly to persist in earning supernormal profit in the long run, unlike firms in perfect competition.” Their response addresses only this point: “States that supernormal profit in a competitive market normally attracts new entrants, which increases supply and competes the profit away over time.” Evaluate the response against the complete 3-mark task. Identify what earns credit and state every additional requirement needed for full marks.
[3 marks] · no calculator
Marking points
- Recognises credit for the stated point: States that supernormal profit in a competitive market normally attracts new entrants, which increases supply and competes the profit away over time.
- Identifies the missing requirement: Explains that high barriers to entry (such as prohibitive start-up costs, patents, or exclusive control of a key input) prevent potential competitors from entering, even when they observe the monopolist earning high profits.
- Identifies the missing requirement: Concludes that without this competitive pressure, the monopolist can continue earning supernormal profit indefinitely, in contrast to the perfectly competitive firm whose profit is eroded by free entry.
Examiner tip: Treat each marking point as a separate requirement. Do not award the same idea twice, and do not infer work the learner did not show.