Topic 4.1 Introduction to Imperfectly Competitive Markets: compare the four market structures, explain why a price maker faces a downward-sloping demand curve with marginal revenue below price, and define barriers to entry.

What this topic is asking

Topic 4.1 sets up the rest of Unit 4 by contrasting imperfectly competitive markets with the perfect competition benchmark. The College Board wants you to compare the four market structures, explain why a price maker faces a downward-sloping demand curve with marginal revenue below price, define market power and barriers to entry, and see why market power leads to inefficiency.

The four market structures

The structures form a spectrum of market power, the ability to set price above marginal cost. Perfect competition (Topic 3.7) sits at one end with zero market power; monopoly sits at the other. The number of firms, the degree of product differentiation, and the height of barriers to entry are what move a market along the spectrum, and they determine how each structure prices, produces, and profits in Topics 4.2 to 4.5.

Why marginal revenue lies below price for a price maker

This is the single most important contrast with perfect competition. A price taker can sell any quantity at the market price, so price equals marginal revenue. A price maker must cut its price to sell more, and because the lower price applies to every unit, the extra revenue from one more unit (marginal revenue) is the new price minus the revenue lost on the units that could have sold at the old higher price. That loss pulls marginal revenue below the price. As a result, when a price maker maximizes profit at $MR = MC$, the price it charges (read off the demand curve) is above marginal cost, the source of the allocative inefficiency that runs through the unit.

Barriers to entry

Barriers to entry are what allow market power to persist. Without them, profit would attract entrants until it was competed away, as in perfect competition. With them, a monopoly or oligopoly can keep earning positive economic profit even in the long run, which is why entry conditions are a key way the structures differ.

Try this

Q1. State why a price maker's marginal revenue is below its price. [2 points]

• Cue. It faces a downward-sloping demand curve, so selling one more unit requires lowering the price on all units, which pulls marginal revenue below the price.

Q2. Identify two barriers to entry that could protect a monopoly. [2 points]

• Cue. Any two of: high start-up costs, patents or licenses, control of a key resource, large economies of scale, or network effects.