Imperfect Competition: every key term you need (+ practice quiz)

More AP Microeconomics guides

• Supply and Demand
• Production, Cost, and the Perfect Competition Model
• Factor Markets
• Market Failure and the Role of Government

Imperfect Competition

Any market structure — monopoly, oligopoly, or monopolistic competition — in which firms have some control over price.

Monopoly

A market with a single seller of a product with no close substitutes, protected by high barriers to entry.

Barriers to Entry

Obstacles that keep new firms out: economies of scale, control of key resources, patents and licenses, and network effects.

Natural Monopoly

An industry where economies of scale are so large that one firm can serve the market at lower average cost than multiple firms (e.g., water utilities).

Price Maker

A firm with market power that chooses its price by choosing where to produce on its downward-sloping demand curve.

MR Below Demand

For any imperfectly competitive firm, marginal revenue lies below price because selling more requires lowering the price on all units.

Monopoly Profit Maximization

Produce where MR = MC, then charge the price on the demand curve above that quantity.

Monopoly Inefficiency

A monopolist produces less and charges more than perfect competition; since P > MC, there is deadweight loss and allocative inefficiency.

Elastic Region Rule

A monopolist always produces on the elastic portion of its demand curve, where MR is positive.

Price Discrimination

Charging different customers different prices for the same product based on willingness to pay, not cost differences.

Conditions for Price Discrimination

The firm needs market power, the ability to segment buyers by willingness to pay, and the ability to prevent resale.

Perfect Price Discrimination

Charging every buyer their maximum willingness to pay; output rises to the efficient level, deadweight loss disappears, but all consumer surplus becomes profit.

Regulation of Natural Monopoly

Regulators may impose a fair-return price (P = ATC, zero economic profit) or a socially optimal price (P = MC, which may require a subsidy).

Monopolistic Competition

Many firms selling differentiated products with low barriers to entry, such as restaurants and hair salons.

Product Differentiation

Making a product distinct through style, quality, location, or branding, which gives each firm a slightly downward-sloping demand curve.

Non-Price Competition

Competing through advertising, branding, and product features rather than price cuts.

Monopolistic Competition Long Run

Entry and exit drive economic profit to zero: demand becomes tangent to ATC, so P = ATC but P > MC and output is below minimum ATC.

Excess Capacity

In long-run monopolistic competition, firms produce less than the output that would minimize ATC — the cost of variety.

Oligopoly

A market dominated by a few large, mutually interdependent firms, with significant barriers to entry.

Mutual Interdependence

Each oligopolist's best choice depends on rivals' choices, so firms must think strategically.

Concentration Ratio

The share of industry output produced by the largest firms (e.g., four-firm ratio); high ratios indicate oligopoly.

Game Theory

The analysis of strategic interaction among interdependent decision-makers, used to model oligopoly behavior.

Payoff Matrix

A table showing each player's outcome for every combination of strategies chosen by the players.

Dominant Strategy

A strategy that gives a player the highest payoff no matter what the other player does.

Nash Equilibrium

An outcome where no player can improve their payoff by unilaterally changing strategy, given the other's choice.

Prisoners' Dilemma

A game in which pursuing individual self-interest leads both players to an outcome worse than cooperation would achieve.

Collusion

An agreement among firms to restrict output or fix prices to act like a monopoly; illegal in the United States.

Cartel

A formal collusive arrangement, like OPEC; cartels are unstable because each member has an incentive to cheat by producing more.

Incentive to Cheat

In a cartel, each firm can raise its own profit by secretly cutting price or exceeding its quota — the logic of the prisoners' dilemma.

Antitrust Policy

Government laws (e.g., the Sherman Act) that prohibit collusion and block mergers that would excessively reduce competition.

Market Power

The ability to charge a price above marginal cost; greatest under monopoly, weakest under perfect competition.

Allocative Comparison of Structures

Only perfect competition (and perfectly price-discriminating monopoly) reaches P = MC output; other structures underproduce.

Monopoly Profit Persistence

Because barriers block entry, a monopolist can earn positive economic profit in the long run, unlike competitive firms.

Demand for a Monopolist

The monopolist's demand curve is the market demand curve itself, since it is the only seller.

Fair-Return Price

Regulated price set where the demand curve crosses ATC, giving the natural monopoly zero economic profit.

Socially Optimal Price

Regulated price set where demand crosses MC, achieving allocative efficiency but often forcing a natural monopoly to take losses.