Forms of Market and Price Determination
What this domain tests
This domain covers perfect competition, monopoly, monopolistic competition, oligopoly, equilibrium of the firm and market, and price controls. Expect questions on features, AR and MR relationships, and the MR = MC condition.
Core rules
- Perfect competition: many buyers and sellers, homogeneous product, free entry and exit, perfect information; the firm is a price taker, so P = AR = MR.
- Monopoly: one seller, no close substitute, barriers to entry; the firm is a price maker and MR is below AR.
- Monopolistic competition: many firms, differentiated products, free entry; each firm has some price power.
- Oligopoly: few firms and interdependence; price rigidity and strategic behaviour are common.
- Firm equilibrium requires MR = MC with MC cutting MR from below. Shutdown depends on price covering average variable cost.
Worked example
In a perfectly competitive market, demand is Qd = 100 - 2P and supply is Qs = 20 + 2P. Equilibrium: 100 - 2P = 20 + 2P, so 80 = 4P and P = 20; Q = 60. A firm takes P = 20, so AR = MR = 20. If AC at Q = 60 is 15, profit per unit is 5 and total profit is 300.
Traps that cost marks
AR = MR applies only under perfect competition. A monopolist has no unique supply curve. MR = MC alone is not enough; MC must cut MR from below. Normal profit is part of cost, not supernormal profit. A price ceiling below equilibrium creates a shortage; a price floor above equilibrium creates a surplus.