Unit 4: Imperfect Competition

Price taker

A firm that cannot influence the market price and can sell any quantity at the going price (typical in perfect competition).

Price maker

A firm with enough market power to influence the price it charges by choosing price or quantity and letting the market respond.

Market power

The ability of a firm to influence the price of its product; associated with a downward-sloping demand curve faced by the firm.

Imperfect competition

Market structures where firms have market power (not price takers), such as monopoly, monopolistic competition, and oligopoly.

Downward-sloping demand curve (for a firm)

A demand curve indicating that to sell more output, the firm must typically lower its price; implies market power.

Marginal revenue (MR)

The additional revenue earned from selling one more unit of output.

MR < P (single-price seller)

A relationship under market power: with downward-sloping demand, marginal revenue is less than price because lowering price to sell more reduces revenue on prior units.

Total revenue (TR)

Revenue from sales; calculated as price times quantity (TR = P · Q).

Economic profit (π)

Profit measured as total revenue minus total cost, including opportunity costs (π = TR − TC).

Profit-maximizing rule (MR = MC)

The output rule for firms with market power: choose quantity where marginal revenue equals marginal cost.

Marginal cost (MC)

The additional cost of producing one more unit of output.

Barriers to entry

Obstacles that prevent new firms from entering a market and competing away long-run economic profit.

Economies of scale (as a barrier)

Cost advantages from producing at large scale; can make it hard for small entrants to compete with a large incumbent’s lower average costs.

High startup costs

Large initial fixed costs that deter entry and can contribute to economies-of-scale advantages for established firms.

Legal barriers to entry

Entry restrictions created by law, such as patents, copyrights, and government licenses.

Control of key resources

A barrier to entry where a firm has exclusive access to an important input needed for production.

Geographic barriers

Location-based advantages that make entry costly or impractical for potential competitors.

Monopoly

A market structure with a single seller, no close substitutes, and high barriers to entry.

Natural monopoly

A monopoly created by very large fixed costs and economies of scale over the relevant output range, often with downward-sloping ATC for market demand.

Monopolist’s demand curve

The market demand curve faced by a monopolist; it is downward sloping and is the same as market demand in monopoly.

Two-step monopoly pricing method

(1) Find Q where MR = MC; (2) use the demand curve at that Q to find the price consumers pay.

No supply curve (monopoly)

Because a monopolist chooses both price and quantity, there is no unique quantity supplied at each price like in perfect competition.

Shutdown rule

A short-run rule: a firm produces if price covers average variable cost (P ≥ AVC); otherwise it shuts down (P < AVC).

Average variable cost (AVC)

Variable cost per unit of output; key for deciding whether to produce in the short run.

Average total cost (ATC)

Total cost per unit of output (fixed + variable); used to determine economic profit or loss at the chosen quantity.

Monopoly profit condition

A monopolist earns positive economic profit at the chosen quantity if price exceeds ATC (P > ATC).

Monopoly loss condition

A monopolist earns an economic loss at the chosen quantity if price is below ATC (P < ATC), even if it still produces in the short run.

Allocative efficiency

An efficiency condition where price equals marginal cost (P = MC), meaning the marginal benefit equals marginal cost.

Productive efficiency

Producing at the lowest possible average total cost; occurs at the minimum point of the ATC curve.

Deadweight loss (DWL)

Lost total surplus from underproduction (or overproduction); in market power models, it is the triangle between demand (MB) and MC over the missing units.

Monopoly underproduction wedge

In monopoly, the firm restricts output so that at the monopoly quantity, price is greater than marginal cost (P > MC).

Monopolistic competition

A market structure with many firms, differentiated products, and relatively easy entry and exit; firms have some market power.

Product differentiation

Brand/feature/location differences that make products imperfect substitutes and give each firm some market power.

Non-price competition

Competing through advertising, branding, service, packaging, or features rather than changing price.

Long-run equilibrium (monopolistic competition)

Entry/exit drives economic profit to zero so that price equals ATC (P = ATC), though firms typically still have P > MC.

Excess capacity

In long-run monopolistic competition, producing less than the output that minimizes ATC; the firm operates on the declining portion of ATC.

Oligopoly

A market dominated by a few large firms whose decisions are interdependent; products may be identical or differentiated.

Interdependence

In oligopoly, the idea that each firm’s best choice depends on expected actions of rivals.

Collusion

Coordination among firms to reduce competition (often by restricting output or raising prices) to increase joint profit.

Cartel

A formal collusive agreement among firms to control price and output.

Game theory

A framework for analyzing strategic decisions when outcomes depend on multiple players’ choices.

Payoff matrix

A table that shows payoffs (often profits) for each player under different combinations of strategies.

Dominant strategy

A strategy that yields a higher payoff regardless of what the other player chooses.

Nash equilibrium

A set of strategies where no player can improve their payoff by changing strategy unilaterally.

Prisoner’s dilemma

A situation where each firm has an incentive to cheat on cooperation, leading to an equilibrium (often mutual cheating) that is worse than cooperation.

Price rigidity

An oligopoly outcome where prices tend not to change frequently even when demand or costs shift modestly.

Kinked demand curve (concept)

An oligopoly idea: demand is more elastic for price increases (rivals don’t follow) and less elastic for price cuts (rivals match), helping explain price rigidity.

Price discrimination

Selling the same (or very similar) product at different prices not explained by cost differences, typically to capture more consumer surplus.

Arbitrage (in price discrimination)

Resale from low-price buyers to high-price buyers; price discrimination requires limited arbitrage so price differences can persist.

Perfect price discrimination

Charging each consumer their maximum willingness to pay; results include P = MC output, no deadweight loss, and consumer surplus driven to zero.

Antitrust policy

Government actions intended to promote competition by preventing or breaking up anti-competitive practices (e.g., collusion), typically lowering price and increasing output.

Marginal cost pricing (regulation)

Regulating a natural monopoly by setting P = MC to achieve allocative efficiency; may require a subsidy if P < ATC.

Average cost pricing / fair-return pricing

Regulating a natural monopoly by setting P = ATC to ensure zero economic profit; usually leaves P > MC so some DWL may remain.