Forms of Market and Price Determination: Competition, Monopoly and Price Controls
The exam tests the features that separate the four market forms, the equilibrium condition of a firm in each, and how demand and supply fix price - including price ceilings and floors.
Perfect competition
Features: many buyers and sellers, homogeneous product, free entry and exit, perfect knowledge, no transport cost. The firm is a price taker, so AR = MR = price. Equilibrium requires MR = MC with MC rising; in the short run P = MC. The firm keeps producing while P ≥ minimum AVC (shut-down point); P = minimum AC is break-even. In the long run free entry drives price to minimum LAC and only normal profit survives.
Other market forms
A monopoly has one seller, no close substitutes and entry barriers; it is a price maker, its AR slopes downward, MR < AR, equilibrium is at MR = MC on the elastic part of demand, and it has no supply curve. Price discrimination needs no resale and differing elasticities. Monopolistic competition has many sellers of differentiated products with selling costs; long-run tangency of AR and AC leaves excess capacity. Oligopoly has few interdependent firms, and the kinked demand curve explains price rigidity.
Price determination
Market equilibrium is where quantity demanded equals quantity supplied. A price ceiling below equilibrium creates shortage, queues, rationing and black markets; a price floor above equilibrium, such as a minimum support price, creates surplus and needs buffer-stock buying.
Worked example
Qd = 100 − 2P and Qs = 20 + 3P. Equating: 100 − 2P = 20 + 3P, so 5P = 80, P = ₹16 and Q = 68. A ceiling of ₹12 gives Qd = 76 and Qs = 56 - a shortage of 20 units, because the ceiling lies below the equilibrium price and therefore binds.
Traps
AR = MR holds only under perfect competition. Since a monopolist's MR is below price, price exceeds MC at equilibrium. A monopolist has no supply curve. Keep ceilings below and floors above equilibrium - reversing them is the commonest error.