Market Structures and Price Determination
Market structures tests the number of sellers, product type, barriers to entry and price power in perfect competition, monopoly, monopolistic competition and oligopoly. You must compare outcomes and apply profit-maximising rules, often with a simple monopoly calculation.
The spectrum of market structures
Perfect competition has many buyers and sellers, homogeneous products, free entry and perfect information; each firm is a price taker with a horizontal demand curve. Monopolistic competition has many firms, differentiated products and some price power. Oligopoly has few large firms, interdependence and possible collusion; Cameroon's mobile telecoms and brewing industries are useful examples. Monopoly has one seller, high barriers and a downward-sloping demand curve.
Profit maximisation
All firms maximise profit where marginal revenue equals marginal cost, provided MC is rising and price covers average variable cost. In perfect competition, price equals marginal revenue, so P = MC in equilibrium. A monopoly faces the market demand curve, so MR is below price; it restricts output and charges a higher price than a competitive market. Normal profit is included in cost; supernormal profit is profit above normal.
Worked example
A monopoly faces demand P = 100 − Q and total cost TC = 20Q, so MC = 20. Total revenue is TR = 100Q − Q², so MR = 100 − 2Q. Set MR = MC: 100 − 2Q = 20, giving Q = 40. Price is P = 100 − 40 = 60. Profit = (P − AC) × Q = (60 − 20) × 40 = 1,600. A perfectly competitive industry with the same cost would set P = MC = 20 and produce Q = 80, so the monopoly restricts output and raises price.
Traps that cost marks
Do not draw a horizontal demand curve for a monopoly; do not say a monopoly can charge any price it likes; do not maximise revenue instead of profit; and do not treat normal profit as waste. In oligopoly, do not assume firms always collude, and in perfect competition do not claim firms earn supernormal profit in the long run.