Market Structures: Perfect Competition and Monopoly — Practice Quiz
A Microeconomics cheat sheet for Market Structures: Perfect Competition and Monopoly — every key formula with its symbols defined — plus a medium-level practice quiz to test recall.
Formulas & key concepts
A price-taking firm maximizes profit by producing the quantity at which marginal cost equals the market price, since for such a firm price equals marginal revenue.
Because a perfectly competitive firm is a price-taker, it faces a horizontal, perfectly elastic demand curve at the market price.
The price equal to a firm's minimum average total cost; at it the firm earns zero economic profit, above it the firm profits, and below it the firm takes a loss.
The price equal to minimum average variable cost; below this price a firm does better producing nothing in the short run.
In the short run a firm keeps producing as long as price at least covers average variable cost (is at or above the shut-down price), even if it cannot cover fixed costs.
A firm's marginal cost curve above its minimum average variable cost, showing how much it will supply at each price in the short run.
A curve showing the total quantity that all firms in an industry supply at each possible price.
The horizontal sum of all firms' short-run supply curves when the number of firms is fixed.
The point where the short-run industry supply curve crosses the demand curve, with the number of firms held fixed.
The situation in which free entry and exit leave no firm with any incentive to enter or leave, and each firm earns zero economic profit.
A curve showing how industry output responds to price once firms have had time to enter or exit; it is more elastic than the short-run curve and is often horizontal.
In long-run equilibrium each competitive firm produces at minimum average total cost with price equal to marginal cost, so output is made at least cost and every consumer willing to pay marginal cost is served.
The ability of a firm, such as a monopolist, to raise the market price by cutting its output; price-taking firms have none.
Unlike a competitive firm, a monopolist faces the entire market's downward-sloping demand curve, which is the source of its market power.
The revenue from one more unit, made up of a positive quantity effect (revenue on the extra unit) and a negative price effect (the lower price now charged on all units), so it is always below the market price.
Because of the price effect, a monopolist's marginal revenue curve always lies below its demand curve.
A monopolist produces where marginal cost equals marginal revenue and then charges the highest price buyers will pay for that quantity, a price that exceeds marginal cost.
Compared with a competitive industry, a monopoly produces less output, charges a higher price, and can earn positive profit in both the short run and the long run.
By setting price above marginal cost, a monopoly shrinks total surplus; the consumer surplus lost outweighs the monopolist's gain, making monopoly a form of market failure.
A government response to natural monopoly in which the state itself owns and operates the firm to serve the public rather than to maximize profit.
A government-imposed limit on the price a monopolist may charge; unlike in a competitive market, a well-chosen price ceiling on a monopoly can raise output and total surplus without causing a shortage.
A monopolist that charges the same price to every customer.
Charging different customers different prices for the same good, based on differences in their willingness to pay or price sensitivity, in order to earn higher profits.
Sellers practicing price discrimination charge higher prices to buyers with less elastic demand and lower prices to those with more elastic demand.
Charging each buyer exactly his or her willingness to pay, letting the seller capture the entire market surplus; it creates no inefficiency but is nearly impossible to carry out in practice.
For much of the twentieth century De Beers controlled most of the world's diamond supply, a classic real-world monopoly built on control of a scarce resource.
Student and senior discounts, airfares that depend on advance purchase, and coupons are common ways firms sort customers by willingness to pay.
Practice quiz
A firm operating in a perfectly competitive market will maximize its profit by producing the quantity at which:
- Marginal revenue equals average total cost.
- Marginal cost equals the market price, i.e., $MC = P$.
- Total revenue is maximized.
- Average variable cost is minimized.
Answer: Marginal cost equals the market price, i.e., $MC = P$.
In the short run, a perfectly competitive firm should continue to produce even if it is incurring losses, as long as the market price is:
- Above its average total cost.
- Below its average fixed cost.
- At or above its minimum average variable cost, i.e., $P \ge min AVC$.
- Equal to its marginal revenue.
Answer: At or above its minimum average variable cost, i.e., $P \ge min AVC$.
Which of the following best describes the demand curve faced by a single firm in a perfectly competitive market?
- Downward-sloping and relatively inelastic.
- Upward-sloping and perfectly elastic.
- Horizontal and perfectly elastic.
- Vertical and perfectly inelastic.
Answer: Horizontal and perfectly elastic.
In a long-run market equilibrium for a perfectly competitive industry, which of the following conditions holds true for each firm?
- $P > MC$ and $P > ATC$.
- $P = MC$ and $P = min ATC$.
- $P < MC$ and $P = AVC$.
- $P = MR$ and $MR < MC$.
Answer: $P = MC$ and $P = min ATC$.
A monopolist maximizes profit by producing the quantity where:
- Marginal revenue equals marginal cost, i.e., $MR = MC$, and then charges a price equal to marginal cost.
- Marginal revenue equals marginal cost, i.e., $MR = MC$, and then charges the highest price buyers will pay for that quantity.
- Price equals marginal cost, i.e., $P = MC$.
- Average total cost is minimized.
Answer: Marginal revenue equals marginal cost, i.e., $MR = MC$, and then charges the highest price buyers will pay for that quantity.
For a single-price monopolist, why is marginal revenue always less than the market price?
- Because the monopolist faces a perfectly elastic demand curve.
- Because of the positive quantity effect and negative price effect.
- Because to sell an additional unit, the monopolist must lower the price on all units sold.
- Because the monopolist's supply curve is perfectly inelastic.
Answer: Because to sell an additional unit, the monopolist must lower the price on all units sold.
The deadweight loss associated with a monopoly is primarily due to:
- The monopolist earning excessively high profits.
- The monopolist producing an output level where $P = MC$.
- The monopolist setting price above marginal cost, i.e., $P > MC$, leading to underproduction relative to the efficient level.
- The high fixed costs incurred by the monopolist.
Answer: The monopolist setting price above marginal cost, i.e., $P > MC$, leading to underproduction relative to the efficient level.
A firm practicing price discrimination will typically charge a higher price to customers with:
- More elastic demand.
- Less elastic demand.
- Higher average variable costs.
- Lower marginal costs.
Answer: Less elastic demand.
The short-run industry supply curve for a perfectly competitive market is derived by:
- Summing the average total cost curves of all firms.
- Horizontally summing the marginal revenue curves of all firms.
- Horizontally summing the short-run supply curves (marginal cost curves above minimum average variable cost) of all firms.
- Vertically summing the demand curves of all firms.
Answer: Horizontally summing the short-run supply curves (marginal cost curves above minimum average variable cost) of all firms.
Which statement accurately describes the efficiency of perfect competition in long-run equilibrium?
- Firms produce at minimum average variable cost, but price is above marginal cost.
- Output is produced at least cost, with $P = MC = min ATC$, and every consumer willing to pay marginal cost is served.
- Firms earn positive economic profits, leading to innovation.
- There is significant deadweight loss due to market power.
Answer: Output is produced at least cost, with $P = MC = min ATC$, and every consumer willing to pay marginal cost is served.
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