Microeconomics · Unit 4: Imperfect Competition · 18 min read · Updated 2026-05-11
Imperfect Competition for AP Microeconomics — AP Microeconomics
AP Microeconomics · Unit 4: Imperfect Competition · 18 min read
1. Monopoly: Price Makers and Deadweight Loss★★☆☆☆⏱ 5 min
Patents and copyrights
Exclusive government licenses
Natural monopoly from economies of scale
Exclusive control of a key input resource
A monopolist faces the full downward-sloping market demand curve. To maximize profit, it chooses output where marginal revenue ($MR$) equals marginal cost ($MC$), then charges the maximum price consumers will pay for that output (read from the demand curve). For any price-making firm, $MR$ always lies below the demand curve: to sell an additional unit, the firm must lower price for all units sold, not just the marginal unit.
Because the monopolist sets $P > MC$, it produces less output than the socially optimal perfectly competitive output, creating a deadweight loss (DWL) of total surplus that is captured by neither consumers nor producers.
Exam tip: Examiners almost always ask you to label DWL on a monopoly graph. Remember DWL is the triangle to the left of the socially optimal output, bounded by the demand curve, $MC$ curve, and the monopoly output line.
2. Monopolistic Competition: Short and Long Run Outcomes★★☆☆☆⏱ 4 min
Product differentiation means each firm faces a gently downward-sloping demand curve. In the short run, firms act like small monopolists, following the $MR=MC$ profit-maximizing rule, and can earn positive economic profit if $P > ATC$ (average total cost) at the profit-maximizing quantity.
In the long run, low barriers to entry mean new firms enter the market when existing firms earn positive profit, shifting existing firms' demand curves left as they lose customers to new entrants. Entry continues until $P = ATC$ at the profit-maximizing output, so long-run economic profit is zero. Firms have excess capacity, producing less than the output that minimizes ATC, creating small DWL that is often offset by consumer value from product variety.
3. Oligopoly and Game Theory★★★☆☆⏱ 5 min
**Payoff Matrix**: A table showing profit for each firm for every combination of actions by all players.
**Dominant Strategy**: An action that gives a firm higher profit no matter what action its competitor takes.
**Nash Equilibrium**: A stable outcome where no firm can increase its profit by changing its action, given competitors' actions.
**Collusion**: An illegal agreement between firms to set high prices and restrict output to act like a monopoly; collusive agreements are unstable because each firm has an incentive to cheat.
4. Price Discrimination★★★☆☆⏱ 4 min
Three conditions must be met for price discrimination to be profitable: (1) the firm has market power (is a price maker), (2) the firm can separate customers into groups with different price elasticities of demand, (3) the firm can prevent resale of the good between customer groups.
Two common types are tested on the AP exam: First-degree (perfect) price discrimination charges each customer their maximum willingness to pay, eliminating all consumer surplus and producing the socially optimal output with zero DWL. Third-degree price discrimination charges different prices to distinct customer groups, following the inverse elasticity rule: higher prices for groups with less elastic demand, lower prices for groups with more elastic demand.
5. Exam-Aligned Concept Check★★★☆☆⏱ 4 min
Common Pitfalls
Why: Students confuse price-making firms with perfect competition, where $P=MR$ always holds.
Why: Students confuse monopolistic competition with monopoly, which has high barriers to entry that block new firms.
Why: Students assume firms will collude to maximize total profit, but collusion is not legally enforceable in most markets.
Why: Students associate monopoly power with higher DWL and generalize this to all price discrimination.
Why: Students incorrectly apply the perfect competition profit-maximizing rule to price-making firms.