ECB1101 · Introductory Microeconomics
Market Structures
With cost curves in hand, ECB1101 walks through how much a firm produces under each of the four market structures. A perfectly competitive firm is a price taker facing a flat demand line, so P = MR = AR; it maximises profit at P = MC on the rising arm, keeps producing short-run while P ≥ AVC (the shut-down rule), and in the long run free entry competes economic profit to zero at P = min ATC. A monopolist is the only seller, facing the whole downward demand so that MR < P (for linear demand MR = a − 2bQ); it produces where MR = MC, reads price up to demand (P > MC), restricts output versus the competitive benchmark and creates a deadweight loss — and can price-discriminate. Monopolistic competition is the hybrid: many firms, differentiated products, free entry; each behaves like a mini-monopoly short-run (P > MC) but free entry drives long-run profit to zero at the tangency where demand just touches ATC, leaving excess capacity and a markup. (Oligopoly is named only as a category — no game theory is examined in ECB1101.)
What this chapter covers
- 01Perfect competition: price taker, P = MR = AR
- 02Profit-max at P = MC; shut-down (P ≥ AVC) & break-even
- 03Long-run entry/exit drives profit to zero (P = min ATC)
- 04Monopoly: single seller, MR < P, MR = a − 2bQ
- 05MR = MC → Q*, read P off demand; the deadweight loss
- 06Price discrimination & natural monopoly
- 07Monopolistic competition: short-run mini-monopoly
- 08Long-run tangency (P = ATC), excess capacity & markup
- 09The four-structure comparison table
Worked example: monopoly profit-max and the markup
- +2(a) For inverse demand P = a − bQ, MR shares the intercept and has twice the slope: with a = 100, b = 2, MR = 100 − 4Q.
- +2(b) Set MR = MC: 100 − 4Q = 20, so 4Q = 80 and Q* = 20.
- +1(b) Read the price up to demand at Q* = 20: P* = 100 − 2×20 = $60 (never off MR or MC).
- +1(c) P* = $60 > MC = $20, the monopoly markup. The competitive (efficient) benchmark is P = MC = $20 at Q = 40; the gap between Q* = 20 and Q = 40 is the restricted output that creates the deadweight loss.
Key terms
- Price taker (perfect competition)
- A firm so small relative to its market that it cannot move the price; it faces a horizontal demand line at the market price, so P = MR = AR. It maximises profit at P = MC on the rising arm of MC.
- Shut-down rule
- In the short run a firm should keep producing as long as price covers avoidable (variable) cost: produce iff P ≥ min AVC; otherwise shut down and lose the fixed cost. Long-run exit instead compares price to min ATC — don't swap the two.
- Marginal revenue (monopoly)
- For a monopolist facing downward demand, MR < P, because selling one more unit means cutting the price on all earlier units (the price effect). For linear inverse demand P = a − bQ, MR = a − 2bQ: same intercept, twice the slope.
- Deadweight loss of monopoly
- The surplus destroyed when a monopolist produces Qm (where MR = MC) instead of the efficient Qc (where P = MC). The units between Qm and Qc are worth more to buyers than they cost, but are never made — lost to everyone.
- Long-run tangency (monopolistic competition)
- The long-run equilibrium where free entry has shifted each firm's demand left until it just touches ATC at q*: P = ATC, so economic profit = 0. Because the tangency is on the falling arm of ATC, the firm has excess capacity (q* < min ATC) and a markup (P > MC).
Market Structures FAQ
When should a competitive firm produce, and when should it shut down?
It maximises profit by producing where P = MC on the rising arm of MC. Whether to produce at all depends on two threshold prices. In the short run, keep producing as long as P ≥ min AVC, because fixed cost is sunk for the period and every unit that covers its variable cost chips away at that fixed cost; if P < min AVC, shut down and lose only the fixed cost. The break-even price is P = min ATC (zero economic profit). A firm running at a loss should often still produce: a loss of, say, −$40 beats shutting down and losing the whole fixed cost. Shut down at AVC, exit at ATC — don't swap them.
Why is a monopolist's marginal revenue below its price?
Because the monopolist is the whole market, so to sell one more unit it must lower the price on EVERY unit it was already selling. Selling the extra unit adds its price (the output effect, +P), but cutting the price loses revenue on all earlier units (the price effect, −). The two together make MR less than P for any positive quantity. A price taker has no price effect, so for it MR = P. For linear inverse demand P = a − bQ the shortcut is MR = a − 2bQ: same intercept, twice the slope.
What's the most common monopoly exam trap?
Reading the price off the wrong curve. The chain is: set MR = MC to get Q*, then read P* straight UP to the DEMAND curve — never off MR or off MC. Setting P = MC (the competitive rule) or reading price off MR are the two errors baited every year. Two more: a monopoly has NO supply curve (it chooses a point on demand, not a quantity for each price), and a change in FIXED cost leaves Q* and P* unchanged because it doesn't touch marginal revenue or marginal cost — only profit moves.
How is monopolistic competition different from monopoly and from perfect competition?
It's the hybrid. Like a monopoly, each firm faces a downward (but elastic) demand, so short-run it sets MR = MC, charges P > MC, and can earn profit or loss. Like perfect competition, free entry drives long-run economic profit to ZERO. The long-run resting point is the tangency where demand just touches ATC: P = ATC so profit = 0, but because the tangency is on the falling arm of ATC, the firm keeps a markup (P > MC) and carries excess capacity (q* below min ATC). So it takes the markup of monopoly but the zero long-run profit of competition. Oligopoly is named only as a category — no game theory is examined in ECB1101.
Exam move
Each structure has a reliable Section C diagram — practise drawing them from a blank axis with every curve labelled. Perfect competition: MC and ATC, a horizontal price line, q* where P = MC on the rising arm, and the shaded profit/loss rectangle (P − ATC)×q*; know the shut-down (P ≥ AVC) and break-even (P = min ATC) rules cold. Monopoly: D, MR (twice the slope), MC; Q* where MR = MC, P* read up to demand, the profit rectangle and the DWL triangle out to the competitive Qc — never set P = MC or read price off MR. Monopolistic competition: the short-run mini-monopoly with profit, then the long-run tangency where demand touches ATC (P = ATC, profit = 0, excess capacity). Be ready to complete the four-structure comparison table as a spectrum from P = MC, zero profit (perfect competition) to P > MC, positive profit (monopoly).
