Ch5. Market Structures — Perfect Competition, Monopoly & Oligopoly

Market Structure Comparison

┌──────────────┬───────────────┬──────────────┬──────────┬────────────┐
│ Feature      │ Perfect       │ Monopolistic │Oligopoly │ Monopoly   │
│              │ Competition   │ Competition  │          │            │
├──────────────┼───────────────┼──────────────┼──────────┼────────────┤
│ # 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 │ restaurants  │ airlines │ local      │
│              │ commodity mkts│ clothing     │ telecoms │ 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 price on all units to sell more)

MR and Demand:
  MR = P(1 − 1/|ε|)
  |ε| > 1 (elastic)  → MR > 0
  |ε| = 1            → MR = 0
  |ε| < 1 (inelastic)→ MR < 0

Monopoly Profit Maximization:
  Set output where MR = MC
  Read price off the demand curve → P > MC
  → Social deadweight loss (DWL)

Inefficiency:
  Output lower and 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.