Market Structures: Perfect Competition and Monopoly — Hard Practice Quiz
A Microeconomics cheat sheet for Market Structures: Perfect Competition and Monopoly — every key formula with its symbols defined — plus a hard-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 perfectly competitive firm is currently producing at a quantity where $P = MC$, but $P < ATC$. What is the firm's short-run production decision, and what is the likely long-run outcome for the industry?
- The firm will shut down immediately; in the long run, firms will exit the industry, raising prices.
- The firm will continue to produce in the short run if $P \ge AVC$; in the long run, firms will exit, and the market price will rise until $P = min ATC$.
- The firm will continue to produce in the short run if $P \ge AVC$; in the long run, firms will enter, and the market price will fall.
- The firm will shut down immediately; in the long run, firms will enter the industry, lowering prices.
Answer: The firm will continue to produce in the short run if $P \ge AVC$; in the long run, firms will exit, and the market price will rise until $P = min ATC$.
Consider a single-price monopolist. If a government regulator imposes a price ceiling equal to the firm's marginal cost ($P = MC$), how will the monopolist's output, consumer surplus, and deadweight loss change compared to its unregulated profit-maximizing outcome?
- Output will decrease, consumer surplus will decrease, and deadweight loss will increase.
- Output will increase, consumer surplus will increase, and deadweight loss will be eliminated.
- Output will increase, consumer surplus will increase, but deadweight loss will remain due to the monopolist's market power.
- Output will decrease, consumer surplus will increase, and deadweight loss will be eliminated.
Answer: Output will increase, consumer surplus will increase, and deadweight loss will be eliminated.
In a perfectly competitive industry with identical firms, if the market demand for the product increases, leading to positive economic profits in the short run, what will be the shape of the long-run industry supply curve if input prices remain constant?
- Upward-sloping, as new firms enter and costs increase.
- Downward-sloping, as new firms enter and economies of scale are realized.
- Horizontal, as new firms enter and drive the price back to the minimum average total cost.
- Vertical, as the industry reaches its maximum capacity.
Answer: Horizontal, as new firms enter and drive the price back to the minimum average total cost.
A monopolist can either charge a single price or perfectly price discriminate. If the monopolist switches from being a single-price monopolist to a perfect price discriminator, what is the impact on total surplus and the monopolist's profit?
- Total surplus decreases, and the monopolist's profit decreases.
- Total surplus increases, and the monopolist's profit increases.
- Total surplus remains the same, but the monopolist's profit increases by capturing all consumer surplus.
- Total surplus increases, and the monopolist's profit remains the same.
Answer: Total surplus increases, and the monopolist's profit increases.
A perfectly competitive firm is operating in the short run. If the market price ($P$) is such that $min AVC < P < min ATC$, which of the following statements is true regarding its production decision and economic profit?
- The firm should shut down immediately because it is incurring losses, and it earns zero economic profit.
- The firm should continue to produce in the short run, covering its variable costs and some fixed costs, but it earns negative economic profit.
- The firm should continue to produce in the short run, covering all its costs and earning positive economic profit.
- The firm should shut down immediately because it cannot cover its average total costs, and it earns positive economic profit.
Answer: The firm should continue to produce in the short run, covering its variable costs and some fixed costs, but it earns negative economic profit.
For a single-price monopolist, why does the marginal revenue curve always lie below the demand curve?
- Because the monopolist must lower the price on all units sold to sell an additional unit, leading to a negative price effect.
- Because the monopolist faces a perfectly elastic demand curve, so $MR = P$.
- Because the monopolist's costs are increasing, which reduces the revenue from additional units.
- Because the monopolist can charge different prices to different customers, making $MR$ less than $P$.
Answer: Because the monopolist must lower the price on all units sold to sell an additional unit, leading to a negative price effect.
In a long-run perfectly competitive equilibrium, what conditions ensure that output is produced at the least possible cost and that every consumer willing to pay the marginal cost is served?
- Firms produce where $MR = MC$, and $P > ATC$.
- Firms produce where $P = MC$, and $P = min ATC$.
- Firms produce where $P = AVC$, and $P = MC$.
- Firms produce where $MR = ATC$, and $P = MC$.
Answer: Firms produce where $P = MC$, and $P = min ATC$.
Compared to a perfectly competitive industry with identical cost structures, how does a single-price monopoly affect the equilibrium quantity and price in the market?
- A monopoly produces more output and charges a lower price.
- A monopoly produces less output and charges a higher price.
- A monopoly produces the same output but charges a higher price.
- A monopoly produces less output but charges the same price.
Answer: A monopoly produces less output and charges a higher price.
A firm practices price discrimination by segmenting its market into two groups, A and B. If group A has a more elastic demand for the product than group B, how should the firm set its prices to maximize profit?
- Charge a higher price to group A and a lower price to group B.
- Charge a lower price to group A and a higher price to group B.
- Charge the same price to both groups, as price discrimination is illegal.
- Charge a price equal to marginal cost for both groups.
Answer: Charge a lower price to group A and a higher price to group B.
Suppose a perfectly competitive industry is in long-run equilibrium. If there is a permanent decrease in market demand, describe the sequence of events in the short run and long run.
- Short run: Price falls, firms incur losses, some shut down. Long run: Firms exit, supply decreases, price rises back to $min ATC$.
- Short run: Price falls, firms earn positive profits. Long run: Firms enter, supply increases, price falls further.
- Short run: Price rises, firms incur losses. Long run: Firms exit, supply decreases, price rises above $min ATC$.
- Short run: Price falls, firms continue to earn zero economic profit. Long run: No change in the number of firms or price.
Answer: Short run: Price falls, firms incur losses, some shut down. Long run: Firms exit, supply decreases, price rises back to $min ATC$.
Select a subject
Select a subject from the left panel to begin exploring formulas.