Forms of Market and Price Determination
What this domain tests
This domain asks you to compare perfect competition, monopoly, monopolistic competition and oligopoly, and to find a firm’s equilibrium output using marginal revenue and marginal cost.
Core rules
- Perfect competition: many buyers and sellers, homogeneous product, free entry and exit, perfect information. A firm is a price taker, so its demand curve is horizontal.
- Monopoly: one seller, no close substitute, strong barriers to entry. The firm is a price maker and faces a downward-sloping demand curve.
- Monopolistic competition: many sellers, product differentiation, free entry; each firm has some price control.
- Oligopoly: few large firms, interdependence; pricing behaviour may involve price rigidity.
- Equilibrium: MR = MC and MC must be rising. Profit = TR − TC; maximum profit occurs at the equilibrium quantity.
Worked example
A perfectly competitive firm sells at ₹20. At 10 units, TC = ₹150, so TR = ₹200 and profit = ₹50. If MR = MC = ₹20 at 10 units, this is the profit-maximising output. If price fell to ₹15 and the firm’s minimum AVC were ₹18, the firm would shut down in the short run despite some output reducing losses.
Traps that cost marks
Do not give a monopoly a horizontal demand curve. Do not say perfect competition has product differentiation. Do not treat normal profit as abnormal profit. In the short run a firm may produce at a loss if price covers AVC. MR = MC is necessary but MC must also be rising for equilibrium.