Market Structure
What this domain tests
CAPE Unit 1 tests how market structure changes price, output and efficiency. You must compare perfect competition, monopoly, monopolistic competition and oligopoly using assumptions, revenue diagrams and the profit-maximising rule MR = MC. Expect questions on barriers to entry, concentration ratios, collusion, price discrimination and dynamic versus allocative efficiency.
Core rules
- Perfect competition: many price-taking firms, homogeneous product, free entry/exit, perfect information. In long-run equilibrium P = MR = MC = minimum AC; normal profit only.
- Monopoly: one firm, barriers to entry, downward-sloping demand; MR lies below price. Profit maximised where MR = MC; price read off demand.
- Monopolistic competition: differentiated products, many firms, free entry; short-run supernormal profit attracts entry until demand shifts left to tangency with AC.
- Oligopoly: few firms, interdependence; rivals' reactions matter, so output may be sticky (kinked demand) or collusive. Game theory predicts cooperation is unstable.
- Allocative efficiency requires P = MC; productive efficiency requires production at minimum AC. Monopoly normally misses both unless regulated or contestable.
Worked example
Demand: P = 100 − 2Q; TC = 20 + 4Q + Q², so MC = 4 + 2Q. Monopoly: TR = 100Q − 2Q², MR = 100 − 4Q. Set MR = MC: 100 − 4Q = 4 + 2Q, Q = 16, P = 68. Profit = TR − TC = 1,088 − 340 = 748. Competitive benchmark: P = MC gives 100 − 2Q = 4 + 2Q, Q = 24, P = 52. The monopoly restricts output and raises price; deadweight loss = ½(24 − 16)(68 − 36) = 128.
Traps
- Setting P = MC for an unregulated monopoly instead of MR = MC.
- Calling zero economic profit a loss; normal profit includes opportunity cost.
- Assuming perfect competition has advertising or brand loyalty.
- Treating oligopoly as a single model; outcomes depend on conduct and retaliation.
- Forgetting that price discrimination raises profit by separating markets with different elasticities.