Forms of Market and Price Determination
This domain tests market classification by degree of competition, revenue relationships, and equilibrium output and price under each structure.
Core rules
- Perfect competition: many buyers and sellers, homogeneous product, free entry and exit, perfect knowledge, no transport cost. The firm is a price taker, so P = AR = MR and its demand curve is horizontal; industry demand slopes downward.
- Monopoly: one seller, no close substitute, strong entry barriers. The firm is a price maker, MR < AR, and for linear demand MR falls twice as fast as price.
- Monopolistic competition: many firms, differentiated products, selling costs, free entry; downward-sloping demand with limited pricing power.
- Oligopoly: a few large firms, mutual interdependence, price rigidity, kinked demand curve, cartels possible.
- Equilibrium condition: MR = MC with MC rising; under perfect competition this becomes P = MC. Profit is normal if P = AC, supernormal if P > AC, a loss if P < AC.
- A monopolist can price-discriminate when markets are separable and elasticities differ, charging more in the less elastic market.
- A unique supply curve exists only in competitive markets; a monopolist has none.
Worked example
Demand P = 20 – Q, so TR = 20Q – Q² and MR = 20 – 2Q. With MC = 4, set 20 – 2Q = 4, giving Q = 8 and P = 12. If AC = 8, profit = (12 – 8) × 8 = 32. Under perfect competition P = MC = 4, so output would be 16 at a lower price - showing how monopoly restricts output and raises price.
Traps
Applying P = MC under monopoly. Forgetting that MR = MC needs MC to be rising. Assuming monopolistic competition sells homogeneous goods. Believing a monopolist can charge any price - demand limits it. Missing that MR = AR only when price is constant.