The same product can be sold in a market with a thousand identical sellers or by a single firm with no rivals, and the price you end up paying is wildly different in the two cases. Market structure — how many firms, how similar their products, how easily new firms can enter — is what sets that price. Master the two extremes, perfect competition and monopoly, and everything in between becomes a matter of degree. It is the backbone of first-year micro, and the topic top economics tutors in Central London see most often at exam time.
1 · The spectrum of market structures
Economists sort markets by four features: the number of firms, whether their products are identical or differentiated, how high the barriers to entry are, and — the feature that follows from the first three — whether a firm can influence the price.
- Perfect competition: many small firms, an identical product, free entry. Each firm is a price taker — too small to move the market price.
- Monopolistic competition: many firms, but differentiated products (think coffee shops). Each has a sliver of pricing power.
- Oligopoly: a few large firms whose decisions depend on each other (supermarkets, mobile networks).
- Monopoly: a single firm behind high barriers. It is a price maker — it chooses the point on the demand curve.
The whole tour comes down to one contrast: the price taker at one end, the price maker at the other.
2 · The perfectly competitive firm
Because it is tiny, the competitive firm can sell as much as it likes at the going price and nothing above it. Its own demand curve is therefore horizontal, and price equals marginal revenue equals average revenue: P = MR = AR. Extra output always adds exactly the price to revenue.
To maximise profit the firm produces where marginal cost equals price. Push output until the cost of the last unit just matches what it sells for — beyond that, each unit loses money.
The long run adds the decisive twist. If firms are earning profit, new firms enter, supply rises, and the price falls; if they are making losses, firms leave and the price rises. Entry and exit only stop when profit is exactly zero — which happens where price equals the minimum of average total cost. So the long-run competitive firm sits at the bottom of its ATC curve, earning normal profit and nothing more.
3 · The monopoly
A monopoly faces the whole market demand curve, which slopes down. To sell one more unit it must cut the price — and cut it on every unit, not just the last. So marginal revenue lies below price and falls twice as fast as a straight-line demand curve.
The profit rule is the same — produce where marginal revenue equals marginal cost — but because MR sits below demand, the monopolist stops at a lower quantity and charges a higher price than a competitive market would. That markup is pure profit, and it survives into the long run because the barriers keep entrants out. The cost is borne by society: output is restricted below the efficient level, and the lost trades are a deadweight loss. Price above marginal cost is the signature of market power.
Worked example — the same cost, two structures
Step 1 — A competitive firm’s costs. Total cost is TC = q² + 9, so marginal cost is MC = 2q and average total cost is ATC = q + 9/q (a £9 fixed cost spread over output, plus a rising variable part).
Step 2 — Find minimum ATC. ATC is lowest where its slope is zero: 1 − 9/q² = 0, so q = 3 and ATC = 3 + 3 = £6. At q = 3 marginal cost is 2(3) = £6 too — marginal cost always cuts average cost at its minimum.
Step 3 — The competitive long run. Entry drives the price down to that minimum, P = £6. The firm sets MC = P: 2q = 6, so q = 3, and since P = ATC its economic profit is zero. Normal profit, nothing more.
Step 4 — Now a monopoly. A single firm faces market demand P = 12 − Q, so MR = 12 − 2Q, with a constant marginal cost of MC = £4.
Step 5 — Monopoly output and price. Set MR = MC: 12 − 2Q = 4, so Q = 4. The price comes off demand: P = 12 − 4 = £8. The firm holds output down and charges double its marginal cost.
Step 6 — Monopoly profit. With average cost also £4, profit is (£8 − £4) × 4 = £16 — a rectangle the competitive firm never gets to keep. The markup as a fraction of price, the Lerner index, is (8 − 4)/8 = 0.5, which equals 1 over the demand elasticity of 2 at that point.
Step 7 — The welfare cost. A competitive market with the same £4 cost would produce where P = MC: 12 − Q = 4, so Q = 8 — double the monopoly’s output. The trades the monopolist withholds are a deadweight loss of ½ × (8 − 4) × (8 − 4) = £8.
Could you draw the competitive firm and the monopoly side by side, from memory? Holding both diagrams at once — the cost curves, marginal revenue below demand, the profit rectangle and the deadweight-loss triangle — is exactly what the exam rewards, and exactly what a one-on-one economics tutor rehearses with you until it is automatic. Book a trial session.
Practice
Q1. A monopolist faces P = 100 − 2Q with constant marginal cost £20. Find its output, price, and profit, then the competitive quantity and the deadweight loss.
Q2. A perfectly competitive firm has TC = q² + 16. Find its minimum average total cost, the long-run price, and the output it produces.
Q3. For the monopoly in Q1, compute the Lerner index and confirm it equals 1 over the elasticity of demand at the chosen quantity.
Answers. Q1: MR = 100 − 4Q = 20 gives Q = 20 and P = £60; profit = (60 − 20) × 20 = £800. The competitive quantity solves 100 − 2Q = 20, so Q = 40, and the deadweight loss is ½ × (60 − 20) × (40 − 20) = £400. Q2: ATC = q + 16/q is minimised at q = 4, where ATC = £8 = MC; the long-run price is £8, output 4, profit zero. Q3: Lerner = (60 − 20)/60 = 2/3; the elasticity at (20, 60) is (−½)(60/20) = −1.5, and 1/1.5 = 2/3. They match.
Key takeaways
- Market structure sets the price. More firms, closer substitutes and lower barriers push a market toward the competitive outcome; fewer firms and higher barriers push it toward monopoly.
- The competitive firm is a price taker: it produces where P = MC, and long-run entry drives it to the minimum of average cost with zero economic profit.
- The monopoly is a price maker: because MR lies below price, it restricts output, charges a markup, and keeps supernormal profit behind its barriers.
- Monopoly’s markup creates deadweight loss — output below the efficient level — which is why P > MC is the hallmark of market power.
Why Central London students choose our economics tutoring
- Course-matched tutors: whether your micro module is at LSE, UCL, King’s or City, sessions use your professor’s notation and the exact firm-versus-market diagrams your exam expects.
- Both diagrams, cold: you leave able to draw the competitive firm and the monopoly from memory — cost curves, MR, the profit rectangle and the deadweight-loss triangle — because that is what earns the marks.
- One-on-one problem sets: a private tutor works the numerical questions with you until MR = MC and P = MC are second nature, not a scramble in the exam hall.
FAQ
Q: What are the four main market structures?
A: Perfect competition, monopolistic competition, oligopoly and monopoly. They differ in the number of firms, how differentiated the products are, and how high the barriers to entry are — which together determine how much power a firm has over its price.
Q: Why does a competitive firm make zero profit in the long run?
A: Because entry is free. Any profit attracts new firms, which raises supply and lowers the price until the profit disappears. Equilibrium settles where price equals the minimum of average total cost, so firms earn a normal return and nothing extra.
Q: Why is monopoly output lower than competitive output?
A: A monopolist’s marginal revenue is below its price, because selling more forces it to cut the price on every unit. It therefore stops producing sooner — where MR = MC rather than P = MC — which means a smaller quantity and a higher price.
Q: What is the deadweight loss of monopoly?
A: It is the value of the trades a monopolist prevents by restricting output. Between the monopoly quantity and the competitive quantity, buyers value the good above its marginal cost, so those units are worth producing — but the monopolist does not, and that lost surplus is the deadweight loss.
Q: What is the Lerner index?
A: It is the markup of price over marginal cost as a fraction of price, (P − MC)/P. It measures market power on a scale from zero (perfect competition, price equals marginal cost) upward, and it equals the reciprocal of the price elasticity of demand at the firm’s chosen quantity.
Book one of our Central London economics tutors
Market structures reward the student who can draw both diagrams without hesitating and read the profit and welfare straight off them. A one-on-one session builds exactly that — the price taker, the price maker, and every result the exam tests — on the questions your course sets. Tell us your university and module, and we will match you with the right tutor this week, in person in Central London or online.
