Market structures and price determination
Every firm maximises profit where MR = MC. Market structure, from perfect competition to monopoly, decides whether price equals or exceeds MC and whether supernormal profit lasts.
Market structures compared
| Feature | Perfect competition | Monopolistic competition | Oligopoly | Monopoly |
|---|---|---|---|---|
| Sellers | Very many | Many | Few, interdependent | One |
| Product | Homogeneous | Differentiated | Homogeneous or differentiated | No close substitute |
| Entry | Free | Fairly free | Barriers | Blocked |
| Firm's demand curve | Horizontal (P = AR = MR) | Downward, fairly elastic | Kinked or uncertain | Downward; the industry curve |
| Price and MC | P = MC | P > MC | P > MC | P > MC |
| Long-run profit | Normal only | Normal only | Supernormal possible | Supernormal possible |
| Indian illustration | Close to it: a vegetable mandi | Soaps, restaurants, salons | Telecom, cement, airlines | Indian Railways in rail transport |
Price and output rules
- Perfect competition: the firm is a price taker. In the short run it may earn supernormal profit, normal profit or a loss, and keeps producing while price covers AVC.
- Long run under perfect competition: entry and exit leave P = MR = MC = minimum AC.
- Monopoly: MR lies below AR, and MR = AR(1 − 1/e). With a positive MC, a monopolist always produces on the elastic part of demand (e > 1).
- Monopolistic competition: in the long run AR is tangent to AC on its falling part, leaving excess capacity (Chamberlin). Selling costs matter.
- Price discrimination (Pigou's degrees): first (each unit at the buyer's maximum price), second (by quantity blocks), third (by markets, with a higher price where demand is less elastic).
- Lerner index of monopoly power = (P − MC) ÷ P, which equals 1/e at the profit-maximising point.
Oligopoly models
| Model | Author | Idea |
|---|---|---|
| Duopoly, quantity competition | Cournot (1838) | Each firm chooses output, taking the rival's output as given |
| Duopoly, price competition | Bertrand (1883) | Firms compete on price, which can fall to MC |
| Leader-follower | Stackelberg (1934) | The leader sets output first; the follower reacts |
| Kinked demand | Sweezy; Hall and Hitch (1939) | Rivals match cuts but not rises, so prices are rigid |
| Cartel and price leadership | Collusive models | Firms collude to act like a monopoly, or follow a dominant or barometric price leader |
Worked example: monopoly price and output
A monopolist faces demand P = 100 − 2Q and a constant MC of ₹20, with no fixed cost. Find the profit-maximising output, price and profit.
- TR = P × Q = 100Q − 2Q², so MR = 100 − 4Q.
- Set MR = MC: 100 − 4Q = 20, so 4Q = 80 and Q = 20 units.
- Price from demand: P = 100 − 2 × 20 = ₹60.
- Profit = TR − TC = (60 × 20) − (20 × 20) = 1,200 − 400 = ₹800.
- Check: MR at Q = 20 is 100 − 80 = 20 = MC. Elasticity there = P ÷ (P − MR) = 60 ÷ 40 = 1.5, and MR = 60 × (1 − 1/1.5) = 60 × 1/3 = 20.
Q = 20 units, P = ₹60, profit = ₹800. Lerner index = (60 − 20) ÷ 60 = 0.67 (rounded to two decimals), which equals 1 ÷ 1.5.
NET asks you to match market forms with features, state equilibrium conditions (MR = MC; P = MC = minimum AC), use MR = P(1 − 1/e), and link Chamberlin, Sweezy and Cournot to their models.
Typical MCQ: “At what price elasticity is a firm's total revenue at its maximum?” At unitary elasticity, where MR = 0. Trap: profit peaks where MR = MC, which is not the revenue peak unless MC is zero.
Typical MCQ: “Below which cost should a competitive firm shut down in the short run?” Minimum average variable cost. Trap: not average total cost; a firm that covers AVC but not ATC keeps producing in the short run.
MR = MC in every market; only perfect competition adds P = MC. Sweezy = sticky prices. Chamberlin's firms carry spare capacity.