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Cambridge IGCSE Economics 0455 – Microeconomic Decision‑Makers: Types of Markets

Microeconomic Decision‑Makers – Types of Markets

Learning Objective

Understand how the presence of a single firm (a monopoly) influences price, quality, choice and profit compared with other market structures.

Key Market Structures

Market Structure	Number of Sellers	Product Differentiation	Price‑Setting Power	Typical Example
Perfect Competition	Many	Homogeneous	None – price taker	Agricultural markets
Monopolistic Competition	Many	Differentiated	Limited – some price‑setting	Clothing retailers
Oligopoly	Few	Either homogeneous or differentiated	Significant – strategic interaction	Airline industry
Monopoly	One	Unique product (no close substitutes)	Full – price maker	Public utilities, patented drugs

Monopoly: How a Single Firm Affects the Market

1. Price

In a monopoly the firm faces the market demand curve directly. It chooses the quantity where marginal revenue equals marginal cost (MR = MC) and then sets the price from the demand curve. This results in a price above marginal cost:

\$P_{monopoly} > MC\$

Consequences:

Consumers pay a higher price than in competitive markets.

Higher price can lead to reduced consumer surplus.

2. Quality

Quality outcomes depend on the monopoly’s objectives:

Profit‑maximising monopoly: May provide the lowest quality that still satisfies demand, because improving quality raises costs without guaranteeing higher demand.

Public‑service monopoly (regulated): May be required to meet minimum quality standards.

Without competitive pressure, there is less incentive to innovate or improve quality.

3. Choice

Since there is only one supplier, consumer choice is limited to the product offered by the monopoly. The lack of close substitutes means:

Fewer varieties of features, sizes, or models.

Consumers cannot switch to a rival to obtain a better deal.

4. Profit

Monopolies can earn economic profit in the long run because barriers to entry prevent other firms from entering the market. The profit area on a graph is the rectangle between price and average total cost (ATC) over the quantity produced:

\$\text{Profit} = (P - ATC) \times Q\$

Key points:

If the monopoly is regulated, price caps may limit profit.

Natural monopolies often have high fixed costs, leading to economies of scale that justify a single‑firm structure.

Comparative Summary

Aspect	Perfect Competition	Monopoly
Price relative to marginal cost	\$P = MC\$ (efficient)	\$P > MC\$ (inefficient)
Quality incentives	High – competition forces improvement	Low to moderate – depends on regulation
Consumer choice	Wide – many sellers, many products	Very limited – single product
Long‑run profit	Zero economic profit (free entry)	Positive economic profit (barriers to entry)

Key Take‑aways

A monopoly’s market power allows it to set a price above marginal cost, creating a dead‑weight loss to society.

Quality and choice are generally lower than in more competitive markets, unless the monopoly is subject to strict regulation.

Economic profit can be sustained over time because entry is blocked by legal, technological, or natural barriers.

Suggested diagram: Monopoly price‑setting – demand curve, MR curve, MC curve, ATC curve, showing profit-maximising quantity, price, and economic profit area.

Effect of having only one firm on price, quality, choice, profit