Define the term monopoly power.

Using the figures provided in Table 1, calculate the monthly level of profits Firm A is making at the current level of output, Q’.

Using the relationship P = AR > MR > AC > MC and/or figures provided in Table 1:

State the reason Firm A cannot be a perfect competitor.

Using the relationship P = AR > MR > AC > MC and/or figures provided in Table 1:

Determine whether Firm A should increase or decrease its level of output in order to maximize profits. You must give a reason for your choice.

Using the relationship P = AR > MR > AC > MC and/or figures provided in Table 1:

Determine whether total revenue collected will increase, decrease or remain unchanged if Firm A increases its level of output. You must give a reason for your choice.

Using the relationship P = AR > MR > AC > MC and/or figures provided in Table 1:

Describe how average cost will be affected if Firm A increases its level of output.

Using the relationship P = AR > MR > AC > MC and/or figures provided in Table 1:

Determine whether Firm A is productively efficient at the current level of output. You must give a reason for your choice.

Using the relationship P = AR > MR > AC > MC and/or figures provided in Table 1:

Explain why allocative efficiency is achieved, in the absence of externalities, at a level of output where price (average revenue) is equal to marginal cost.

On the following axes, sketch a fully labelled diagram showing the level of output Q’ for which the relationship
P = AR > MR > AC > MC is true. The use of figures provided in Table 1 is not required.

Now assume that the market in which Firm A operates has evolved into an oligopoly with only two firms, Firm A and Firm B. Each firm can cut price or maintain the current price. The following payoff matrix shows the profits they face. The profit payoffs for Firm A are in bold.

Using the profit figures in the payoff matrix, explain why strategic interdependence will lead both firms to cut price.

Level 
0 The work does not reach a standard described by the descriptors below. [0]

1 Vague definition. [1] 
The idea that the firm faces a negatively sloped demand curve OR that it arises when one firm dominates the market.

2 Accurate definition. [2]
The ability of a firm to set the price.

Total revenues = 140 × 150 000 = $21 000 000 [1]

Total costs = 60 × 150 000 = $9 000 000 [1]

$\pi$ = TR – TC = 21 000 000 – 9 000 000 = $12 000 000 [1]

OR

$\pi$ = (AR – AC) × Q = (140 – 60) × 150 000 = $12 000 000 [3]

Any valid working is sufficient for [1].

OFR applies for the final figure (assuming that at least either TR or TC is calculated correctly).

An answer of $12 000 000 or 12 000 000 or 12 million without any valid working is sufficient for [1] only.

Price (or average revenue) is greater than (or is not equal to) marginal revenue.

An answer which indicates that P> MR is sufficient for [1].

Level 
0 The work does not reach a standard described by the descriptors below. [0]

1 Correct answer with incorrect reasoning. [1] 
This firm should increase its level of output.

2 Accurate answer. [2]
Since MR>MC (or $80 > $50), this firm should increase its level of output.

Level
0 The work does not reach a standard described by the descriptors below. [0]

1 Correct answer without a valid reason provided. [1]
Total revenue will increase.

2 Accurate answer. [2]
Total revenue will increase because marginal revenue is positive OR the idea that increasing output by one unit will add ($80.00) to total revenue and thus total revenue will increase.

Level
0 The work does not reach a standard described by the descriptors below. [0]

1 Correct answer without a valid reason provided. [1]
Average cost will decrease.

2 Accurate answer. [2]
Average cost will decrease since marginal cost is lower than average cost. Therefore, producing an additional unit of output will reduce average cost.

Level
0 The work does not reach a standard described by the descriptors below. [0]

1 Correct answer without a valid reason provided. [1]
The firm is not productively efficient.

2 Accurate answer. [2]
The firm is not productively efficient, because AC>MC so AC is not at a minimum.

Level
0 The work does not reach a standard described by the descriptors below. [0]

1 The written response is limited. [1–2]
For the idea that welfare loss is zero OR that social (community) surplus (sum of consumer surplus and producer surplus) is maximized.

For a vague reference to surplus or benefit, [1] may be awarded.

2 The written response is accurate. [3–4]
For explaining that as long as price is greater than MC, output should continue to be increased until MB (price) equals MC, because as a result social (community) surplus will be higher OR for explaining that all units valued more than they cost to produce are indeed produced up until the point where price equals marginal cost for the last unit produced.

Some marginal analysis is required for [4]. A response which explains that price is the value placed by society on a product, while MC is the (marginal) cost, and when they are equal, community surplus is maximized, may be awarded [3].

For an accurately drawn diagram of a firm with monopoly power. [1]

The AR curve must be downward sloping and MR must below AR. The MC and AC curves must have the appropriate shapes, and MC should intersect AC at or close to the minimum. However, it is not necessary for MR to be twice as steep as AR.

For accurate labelling of axes and all curves. [1]
N.B. The labels P = AR, MR, AC and MC on the vertical axis are not necessary.

For identifying the level of output that satisfies the relationship. [1]

Level 
0 The work does not reach a standard described by the descriptors below. [0]

1 Vague explanation. [1–2]
Award [1] for each of the following points:

• for a vague explanation that the level of profits attained by their decision depends on the decision made by the rival firm
• profit will be higher if it cuts price.

2 Accurate explanation. [3–4]
For an explanation that uses correctly the figures showing that the level of profits attained by any decision (strategy) depends on the decision (strategy) the rival firm makes and that if Firm B “maintains price” then Firm A can earn more by cutting price as $24 million > $18 million, while if Firm B ‘cuts price’ then Firm A will also cut price, as again profits will be greater ($8 million > $3 million). So Firm A will cut price, no matter which strategy Firm B chooses, and vice-versa.

Award [3] for a response which demonstrates some understanding of strategic interdependence, makes some reference to the data and incorporates the points above. For example, a response which explains that one firm might seek to cut price in order to earn greater profit/market share, causing the other firm to do the same (with some data incorporated).

Award [4] for a response which demonstrates clear understanding, by a precise use of the data, that whatever decision is taken by B, A can earn more by cutting price (as outlined above).

The majority of candidates were able to identify that monopoly power refers to the ability to be a price-setter, although some merely described monopoly as a situation in which one firm dominates the market, earning 1 mark only.

The calculation was performed successfully by the majority of candidates.

The accurate response, that the firm cannot be a perfect competitor because AR ≠ MR, was provided by a significant proportion of the cohort. However, it was common to see responses such as “the firm is making abnormal profit” or “P ≠ MC”, both of which are possible for a perfectly competitive firm (the former in the short run, the latter if the firm is not producing at the profit-maximizing level of output) but not as a defining characteristic of the model.

The majority of candidates were able to realise that increasing output would move output closer to the profit-maximizing level. Higher achieving responses used marginal analysis to support this.

Many candidates were unable to explain that total revenue would increase if output increased because MR was positive and thus producing an additional unit would increase total revenue.

There was a wide range of responses to this question. Lower achieving responses argued that costs would increase as output expands, thus increasing average costs. Many candidates who recognized that AC would decrease explained by writing that economies of scale would operate, or that fixed costs would be spread over an increased quantity. Higher achieving responses explained that as MC<AC, an increase in output must lead to a decrease in AC.

Most candidates recognized that, at the current level of output, MC ≠ AC, and thus productive efficiency is not achieved.

This question was generally answered poorly. Some candidates focused on externalities and market failure, while the majority described the condition for allocative efficiency. Few responses included an explanation which incorporated the idea that, as output increases and approaches the allocative efficient position, the addition to benefit (marginal benefit) exceeds the addition to cost (marginal cost) and hence community surplus increases.

The majority of candidates were able to sketch the four relevant curves (AC, MC, AR, MR) with appropriate shapes, but a common error was to indicate Q’ as the profit-maximizing level of output, hence failing to meet the relationship specified.

Although the majority of candidates were able to explain the payoff matrix, few were able to apply effectively to the concept of strategic interdependence. A large proportion of responses explained that if one firm cut price then it would be in the interests of the other firm to cut price also, and so the firm would react in this manner. A small number of candidates explained that, whatever Firm B decides to do, it is in the interests of Firm A to cut price (and vice-versa) given the assumption that there is no communication between the firms.