Market Structures — Perfect Competition, Monopoly & Oligopoly

Market Structure Comparison

Feature	Perfect Competition	Monopolistic Competition	Oligopoly	Monopoly
# of firms	Many	Many	Few	One
Product	Identical	Differentiated	May vary	Unique
Barriers	None	Low	High	Very high
Price control	None (taker)	Some	Significant	Full
Examples	wheat, stocks commodity mkts	restaurants clothing	airlines telecoms	local utilities

Perfect Competition

Characteristics

Many buyers and sellers
Identical (homogeneous) products
Perfect information
Free entry and exit

Price Taker

P = MR (horizontal demand curve)
Profit maximization: P = MC

Long-Run Equilibrium

P = MC = ATC → economic profit = 0 → Entry/exit drives profit to zero → Allocatively and productively efficient

Monopoly

The Monopolist

Sole supplier → faces the entire downward-sloping market demand curve
MR < P (must lower the price on all units to sell more)

MR and Demand

MR = P\left(1 - \frac{1}{|\varepsilon|}\right)

|ε| > 1 (elastic) → MR > 0
|ε| = 1 → MR = 0
|ε| < 1 (inelastic) → MR < 0

Monopoly Profit Maximization: set output where MR = MC, then read the price off the demand curve → P > MC → social deadweight loss (DWL).

Inefficiency

Output is lower and the price higher than under perfect competition
Antitrust law (Sherman Act § 2) addresses monopolization in the US

Price Discrimination

First-Degree (Perfect)

Different price for every unit / every consumer → All consumer surplus captured by the monopolist

Second-Degree

Price varies by quantity purchased (block pricing, quantity discounts) → Utility tiered pricing (e.g., electric bills)

Third-Degree

Different prices for different consumer groups
Conditions: separable markets, no resale, different price elasticities
Elastic group → lower price
Inelastic group → higher price
Examples: student vs. full-price tickets, domestic vs. international drug pricing

Oligopoly

Characteristics

Few large firms → high interdependence
One firm’s action directly affects rivals

Kinked Demand Curve (Sweezy Model)

Price increase → rivals don’t follow → large loss of customers
Price decrease → rivals match → small gain in customers → Explains price rigidity

Collusion (Cartel)

Firms agree on price and/or output
Behave like a monopolist → joint profit max
Unstable: each firm has incentive to cheat (Prisoner’s Dilemma)
Illegal under US antitrust law (Sherman Act § 1)

Game Theory (Nash Equilibrium)

Nash Equilibrium: each player’s strategy is the best response to the other’s strategy → no unilateral incentive to deviate
Prisoner’s Dilemma: individual rationality leads to collectively suboptimal outcome

Key Concept Cards

Monopoly: MR < P ★★★★★ : To sell one more unit, a monopolist must lower the price on ALL units → MR = P − price-reduction loss < P. Memory hook: monopoly MR < P; perfect competition MR = P

Third-Degree Price Discrimination ★★★★★ : Requires market separation + no resale + different elasticities. Charge less to the elastic group, more to the inelastic group. Memory hook: elastic = discounted; inelastic = premium price

Nash Equilibrium ★★★★☆ : A strategy profile where no player can do better by unilaterally changing strategy. A stable resting point of the game. Memory hook: Nash = no one wants to deviate unilaterally

Practice Questions

Q. Why is P > MC at a monopolist’s profit-maximizing output?

At the profit-maximizing output, MR = MC. Because a monopolist faces a downward-sloping demand curve, MR < P at every positive output level. Therefore, at MR = MC, we have P > MC. This gap — the monopoly wedge — produces deadweight loss and allocative inefficiency relative to perfect competition.

Q. An airline charges students a lower fare and business travelers a higher fare on the same route. What degree of price discrimination is this?

Third-degree price discrimination. The airline segments customers by group (students vs. business travelers) and exploits their different price elasticities. Students have more elastic demand (more alternatives, more time flexibility) → lower price. Business travelers have inelastic demand (less flexibility, company pays) → higher price.