Market Structures and Pricing
What the exam tests
Market structure determines pricing and output. CB2 tests the spectrum from perfect competition to monopoly, oligopoly interdependence, efficiency and price discrimination.
Core rules
- Perfect competition: many firms, homogeneous product, free entry, horizontal firm demand, P = MR. Short-run profit max at P = MC; long-run equilibrium at P = minimum AC with zero economic profit.
- Monopoly: single seller, barriers to entry, downward-sloping demand, MR below price. Profit max at MR = MC; price read from demand. Positive long-run profit possible; deadweight loss arises because P > MC.
- Monopolistic competition: differentiated products, free entry; short-run like monopoly, long-run zero economic profit but excess capacity.
- Oligopoly: few firms, interdependence. Outcomes range from competitive to collusive; kinked demand can explain price rigidity; game theory models strategic behaviour.
- Price discrimination requires market power, separable markets and no arbitrage. First degree extracts all consumer surplus; third degree segments markets.
Worked example
Demand is P = 100 - Q, so MR = 100 - 2Q. MC = 20. Set 100 - 2Q = 20, giving Q = 40 and P = 60. Under perfect competition P = MC = 20, so Q = 80. The monopoly restricts output and raises price. Deadweight loss is the triangle between demand and MC from Q = 40 to 80: 0.5 × (80 - 40) × (60 - 20) = 800.
Traps
- Setting monopoly price equal to MC; the monopolist sets MR = MC and then reads price off demand.
- Drawing MR with the same slope as demand; for linear demand, MR is twice as steep.
- Assuming perfect competition means firms can set price; the firm is a price taker.
- Assuming monopolistic competition is efficient in the long run; zero profit does not mean minimum AC.
- Forgetting that price discrimination can raise output while transferring surplus.