1.5.6 Monopoly and Monopoly Power — Practice Questions

Nine original multiple-choice questions on monopoly and monopoly power, written to the style and difficulty of AQA Paper 3 Section A. Every question carries a full worked model answer.

9 questions AQA A-Level Multiple choice Model answers included

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1. 1. A pure monopoly is best defined as a market in which there is

   Definition in context

   Select one answer

   A A firm holding a market share of 25% or more.

   B A firm that is able to earn supernormal profit in the short run.

   C A single seller of a product with no close substitutes.

   D A small number of firms that dominate total sales.
   Show model answer

   Answer: C (A single seller of a product with no close substitutes.). A pure monopoly is a single seller of a product for which there are no close substitutes, protected by high barriers to entry. Both halves matter: a firm can be the only seller of its own brand and still face fierce competition from near-identical products, in which case it has little real power.

   Why the other options are wrong

   • A — A 25% share is the threshold the Competition and Markets Authority uses to identify a legal or working monopoly. That is a regulatory definition, not the pure economic one, and such a firm plainly has rivals.
   • B — Firms in perfect competition and monopolistic competition can also earn short-run supernormal profit. What distinguishes monopoly is the ability to sustain it, thanks to barriers to entry.
   • D — A few dominant firms is an oligopoly. Monopoly means one.

2. 2. A firm holds a UK market share of over 90% in its industry. Under the definition used by the Competition and Markets Authority, this firm

   Applied reasoning

   Select one answer

   A Has a legal monopoly, because its share exceeds 25%.

   B Has no monopoly power, because rival firms still exist.

   C Is a pure monopoly, because its share exceeds 90%.

   D Is an oligopolist, because it is one of several firms.
   Show model answer

   Answer: A (Has a legal monopoly, because its share exceeds 25%.). The CMA treats any firm with a market share of 25% or more as holding a legal or working monopoly. That threshold matters practically: it is the point at which a firm's conduct can attract regulatory scrutiny, whether or not it is the only seller. A search engine with over 90% of UK searches clears it comfortably.

   Why the other options are wrong

   • B — Rivals existing does not remove monopoly power. With 90% of the market, this firm can influence price and conditions in a way its small competitors cannot.
   • C — A pure monopoly requires a single seller with no close substitutes. Over 90% is dominant but not sole, so the legal definition is the one that applies.
   • D — Oligopoly means a few firms sharing the market between them. One firm holding over 90% is not that.

3. 3. Unlike a firm in perfect competition, a monopolist can sustain supernormal profit into the long run. The main reason is that

   Applied reasoning

   Select one answer

   A Consumers have perfect information about its prices.

   B High barriers to entry keep new firms out.

   C It produces at the minimum point of its average cost curve.

   D Its marginal revenue curve lies above its average revenue curve.
   Show model answer

   Answer: B (High barriers to entry keep new firms out.). In perfect competition, supernormal profit attracts new entrants, supply rises, price falls and the profit disappears. A monopolist is protected by high barriers to entry — patents, ownership of a key resource, enormous set-up costs, legal restrictions — so that mechanism never operates. The profit therefore persists indefinitely, which is the central difference between the two market structures over time.

   Why the other options are wrong

   • A — Perfect information is a feature of perfect competition, and monopoly is in fact associated with asymmetric information. Either way, information does not explain persistent profit.
   • C — A profit-maximising monopolist typically does not produce at minimum average cost. Producing efficiently would not by itself protect profit from competition anyway.
   • D — Marginal revenue lies below average revenue for any firm facing a downward-sloping demand curve, including a monopolist.

4. 4. Sketching the standard monopoly diagram at the profit-maximising output, the price charged will be

   Applied reasoning Sketch to solve

   Select one answer

   A Above marginal cost, so the outcome is allocatively inefficient.

   B Above marginal cost, so the outcome is allocatively efficient.

   C Equal to marginal cost, so the outcome is allocatively efficient.

   D Below marginal cost, so the firm makes a loss on the last unit.
   Show model answer

   Answer: A (Above marginal cost, so the outcome is allocatively inefficient.). Sketch a downward-sloping AR curve with MR beneath it, and a rising MC curve. The monopolist maximises profit where MC = MR, then reads the price up from that quantity to the AR curve — which lies above MR, and therefore above MC.
   Because P > MC, the value consumers place on an extra unit exceeds the cost of producing it, so society would gain from more being made. Too little is produced, which is allocative inefficiency, and the resulting welfare loss is the standard case against monopoly.

   Why the other options are wrong

   • B — The first half is right and the conclusion is wrong. Allocative efficiency requires P = MC exactly; any gap between them means the wrong quantity is being produced.
   • C — P = MC is the perfectly competitive outcome, where the horizontal demand curve makes AR and MR the same line. A monopolist's AR sits above its MR, so price must exceed marginal cost.
   • D — Price below marginal cost would mean losing money on the last unit, which no profit-maximising firm would choose. The monopolist's problem for society is the opposite — charging too much, not too little.

5. 5. A natural monopoly is best described as an industry in which

   Definition in context

   Select one answer

   A One firm can supply the whole market more cheaply than several.

   B A single firm has been granted a legal right to be the only supplier.

   C Firms use natural resources that cannot be replaced once used.

   D The government owns the only firm operating in the market.
   Show model answer

   Answer: A (One firm can supply the whole market more cheaply than several.). A natural monopoly arises where fixed costs are so large relative to the market that average cost keeps falling across the whole range of demand. Duplicating the infrastructure — a second set of water mains or rail track alongside the first — would raise average cost for everyone. One supplier is therefore the cheapest arrangement, which is why such industries are usually regulated rather than broken up.

   Why the other options are wrong

   • B — A legally granted exclusive right is a statutory monopoly. It may or may not also be natural; what defines a natural monopoly is the cost structure, not the law.
   • C — This describes non-renewable resources, which is an entirely different idea from a monopoly market structure.
   • D — Public ownership is a question of who owns the firm. Natural monopolies exist in private hands too, which is exactly why regulators supervise them.

6. 6. Which one of the following is most likely to be a benefit of monopoly power?

   Applied reasoning

   Select one answer

   A Allocative efficiency, because price is set equal to marginal cost.

   B Lower barriers to entry, because the firm has no need to protect itself.

   C Productive efficiency, because output is at minimum average cost.

   D Supernormal profit funding research and development.
   Show model answer

   Answer: D (Supernormal profit funding research and development.). The strongest case for monopoly is dynamic efficiency. Sustained supernormal profit gives a monopolist both the funds and the incentive to invest in research and development, since the barriers protecting it mean the returns on any innovation can be captured rather than immediately copied. Large-scale production can also deliver economies of scale, so average costs may be lower than under a fragmented industry.

   Why the other options are wrong

   • A — A monopolist charges a price above marginal cost, so the outcome is allocatively inefficient. This is a cost of monopoly rather than a benefit.
   • B — High barriers to entry are what make monopoly possible. A monopolist has every reason to maintain them, not to lower them.
   • C — A profit-maximising monopolist produces where MC = MR, which is not normally the minimum of its average cost curve. Productive inefficiency and X-inefficiency are among the usual criticisms.

7. 7. A monopolist faces no competitive pressure and its average costs drift upwards as the organisation becomes slack. This is best described as

   Applied reasoning

   Select one answer

   A Allocative inefficiency.

   B Diseconomies of scale.

   C Dynamic inefficiency.

   D X-inefficiency.
   Show model answer

   Answer: D (X-inefficiency.). X-inefficiency is the rise in average cost that comes from a lack of competitive pressure: without rivals threatening to take its customers, a firm has weaker incentives to control costs, and organisational slack creeps in. It is distinct from the other inefficiencies because it is about management rather than about the quantity produced or the scale of operation.

   Why the other options are wrong

   • A — Allocative inefficiency is producing the wrong quantity, with price above marginal cost. That is a separate criticism of monopoly and it concerns output, not costs.
   • B — Diseconomies of scale raise average cost because the firm has grown too large to coordinate. Here the cause is the absence of competition, not size.
   • C — Dynamic inefficiency would mean failing to innovate over time. Slack cost control is a present-day inefficiency rather than a failure to improve in future.

8. 8. Table 1 lists three features of a market.
   Using Table 1, which one of the following combinations is most consistent with a firm holding substantial monopoly power?

   Data interpretation

   Table 1: Three features of a market

   Feature	Description
   1	Barriers to entry
   2	Availability of close substitutes
   3	The firm's share of total market sales

   Select one answer

   A 1 high, 2 few, 3 high.

   B 1 high, 2 many, 3 low.

   C 1 low, 2 few, 3 high.

   D 1 low, 2 many, 3 low.
   Show model answer

   Answer: A (1 high, 2 few, 3 high.). Monopoly power grows with all three working in the same direction.
   High barriers keep potential rivals out, so profit is not competed away.
   Few close substitutes mean customers cannot easily switch, so demand is price inelastic and the firm can raise price without losing them.
   A high market share means the firm's own decisions move the market.
   Together these give real power to set price.

   Why the other options are wrong

   • B — Many substitutes and a low share leave the firm unable to raise price without losing customers, whatever the barriers to entry.
   • C — A high share with low barriers is fragile: any attempt to exploit that position would attract entrants almost immediately. This is closer to a contestable market.
   • D — This is the profile of a highly competitive market — easy entry, plenty of alternatives, and no firm large enough to matter.

9. 9. A regulator requires a natural monopoly supplying water to set its price equal to marginal cost. All other things being equal, the most likely difficulty with this rule is that the firm will

   Applied reasoning

   Select one answer

   A Be unable to charge different prices to different consumers.

   B Make a loss, because average cost is still falling at that output.

   C Produce too little water, because the price is set too low.

   D Retain supernormal profit, because marginal cost is above average cost.
   Show model answer

   Answer: B (Make a loss, because average cost is still falling at that output.). A natural monopoly has very large fixed costs and low marginal costs, so its average cost falls continuously across the relevant range of output. Whenever average cost is falling, marginal cost lies below it. Setting price equal to marginal cost therefore sets price below average cost, and the firm loses money on every unit.
   The result is allocatively efficient but financially impossible without support, which is why regulators typically use average cost pricing or a subsidy instead — accepting a little inefficiency in exchange for a firm that can survive.

   Why the other options are wrong

   • A — Price discrimination is a separate matter and is not what the rule prevents. The difficulty is that the single regulated price does not cover costs.
   • C — Marginal cost pricing produces more output than the monopolist would choose, not less. That is the point of the rule — the problem is the loss it creates, not the quantity.
   • D — This inverts the cost relationship. With average cost falling, marginal cost is below average cost, so a price equal to MC cannot leave any profit.