Market Structures and Price/Output Decisions
This section covers perfect competition, monopoly, monopolistic competition and oligopoly, which the exam tests through features, profit maximisation and efficiency comparisons. You should be able to apply MR = MC and identify how market power affects price and output.
Core rules
- Perfect competition: many sellers, homogeneous product, free entry and exit, perfect information. Each firm is a price taker, so P = MR = AR. In the long run, normal profit only, with P = minimum AC.
- Monopoly: one seller, high barriers, downward-sloping demand, MR below price. A monopolist can earn long-run supernormal profit but is constrained by demand.
- Monopolistic competition: many sellers, differentiated products, some price power, free entry. Short-run profit attracts entry; long-run profit tends to normal.
- Oligopoly: few large firms, interdependence, possible collusion or price rivalry. Game theory and kinked demand are relevant.
- Profit is maximised where MR = MC and MC cuts MR from below. Normal profit is included in economic cost.
- Allocative efficiency requires P = MC; monopoly generally restricts output and charges P > MC.
Worked example
A monopolist faces P = 100 - Q and TC = 20Q. Total revenue = 100Q - Q², so MR = 100 - 2Q. MC = 20. Set MR = MC: 100 - 2Q = 20, so Q = 40. Price = 100 - 40 = 60. Profit = (P - AC) × Q = (60 - 20) × 40 = 1,600. A perfectly competitive industry with the same cost would produce where P = MC, giving 100 - Q = 20 and Q = 80, a larger output and lower price.
Traps
Do not maximise revenue instead of profit; do not say a monopoly has a supply curve; do not forget normal profit is a cost; do not assume oligopoly always colludes.