AP Microeconomics Unit 4 Cheat Sheet: Imperfect Competition

The basics

What it covers: What market power is and where it comes from, monopoly pricing and deadweight loss, price discrimination, monopolistic competition and excess capacity, and oligopoly behaviour through game theory.

Exam weight: About 15–22% of the AP Microeconomics exam.

The big question: When a firm can influence its own price, how much does it produce, what does it charge, and what does society lose compared with perfect competition?

Recurring themes: MR lies below price whenever demand slopes down; quantity comes from MR = MC but price comes from demand; P > MC means deadweight loss; entry destroys long-run profit wherever it is possible.

Key topics at a glance

Imperfectly Competitive Markets

Four structures: perfect competition (many firms, identical goods, free entry) → monopolistic competition (many firms, differentiated goods, free entry) → oligopoly (few interdependent firms) → monopoly (one firm, blocked entry). Market power rises as you move down the list.

Monopoly

One seller, no close substitutes, high barriers to entry. The firm's demand curve is market demand, so MR < P. Produce where MR = MC, price up on the demand curve. Profit is not guaranteed — if ATC sits above demand, the monopolist loses money.

Marginal Revenue

MR < P for every price maker. With linear demand, MR shares the vertical intercept and has twice the slope, hitting the x-axis at half the demand quantity. MR is positive when demand is elastic, zero at unit elastic, negative when inelastic — a monopolist never produces where MR is negative.

Deadweight Loss

The cost of market power. Since P > MC, mutually beneficial units go unproduced. On the graph it is the triangle bounded by demand above, MC below, running from the monopoly quantity out to the efficient quantity where demand crosses MC.

Regulating a Natural Monopoly

Two candidate prices: the socially optimal price sets P = MC (allocatively efficient, but usually a loss since MC < ATC while ATC falls), and the fair-return price sets P = ATC (zero economic profit, still not allocatively efficient).

Price Discrimination

Requires market power, separable buyers, and no resale. Under perfect price discrimination the firm charges each buyer their willingness to pay: MR becomes the demand curve, output rises to the efficient quantity, deadweight loss vanishes, and all consumer surplus is converted into producer surplus.

Monopolistic Competition

Short run: looks like a small monopoly — profit or loss is possible. Long run: entry (or exit) shifts each firm's demand until it is tangent to ATC, so economic profit is zero. The firm sits left of minimum ATC — that gap is excess capacity.

Oligopoly and Game Theory

Few firms, mutual interdependence. Collusion mimics monopoly but is unstable because cheating pays. Read a payoff matrix by finding each player's best response to each rival strategy; a cell where both are best-responding is a Nash equilibrium.

The key terms you must know

Market power — the ability to influence price by changing output; equivalent to facing a downward-sloping demand curve.
Barrier to entry — patents, licences, resource control, or economies of scale that keep new firms out.
Marginal revenue (MR) — the revenue from one more unit; always below price for a price maker.
Deadweight loss — surplus destroyed because output stops short of where P = MC.
Natural monopoly — economies of scale so large that one firm serves the market most cheaply.
Socially optimal price / fair-return price — P = MC (efficient) vs. P = ATC (zero profit).
Price discrimination — different prices to different buyers for cost-unrelated reasons.
Excess capacity — producing left of minimum ATC, the hallmark of long-run monopolistic competition.
Dominant strategy / Nash equilibrium — best regardless of the rival's move / no one gains by deviating alone.

Key themes to remember

MR < P is the engine of the whole unit. Monopoly pricing, deadweight loss, and the failure of allocative efficiency all trace back to it.
Quantity from MR = MC, price from demand. Two separate curves do two separate jobs — never read price off MR.
Entry is what kills long-run profit. Monopoly keeps profit because entry is blocked; monopolistic competition loses it because entry is free.
Efficiency is the benchmark, not the outcome. Only perfect competition (and perfect price discrimination, oddly) reaches allocative efficiency.
Oligopoly is about anticipation. Payoff matrices exist because a firm's best move depends on a rival's choice, which no other structure requires.

Common exam traps

Don't read the monopoly price off the MR curve. Find quantity at MR = MC, then go vertically up to demand. This is the most-lost point in the entire unit.
Monopolies are not guaranteed profit. If ATC lies above demand at the MR = MC quantity, the monopolist minimizes a loss instead.
Perfect price discrimination is allocatively efficient. It is efficient and deeply unequal at the same time — output is optimal, but consumers keep none of the surplus.
Zero long-run profit does not mean efficient. Monopolistic competition earns zero profit like perfect competition, yet still has excess capacity and P > MC.
A Nash equilibrium need not use dominant strategies. A game can have a Nash equilibrium with no dominant strategy at all — check best responses cell by cell.
Deadweight loss is measured to the efficient quantity, not to the demand intercept. The triangle ends where demand crosses MC.