Comparing Market Structures

In perfect competition, the demand is perfectly elastic.  The producer is a price taker in that if he tries to sell for more he won't sell any product as all of his competitors are selling for the same price (P1) and if he lowers his price he'll just be losing money because the market is willing to pay the price P1.  The only variable is the quantity to be sold.  If the producer sells at output quantity Q1 then he will realize economic profit since the average revenue is above the average cost.

In monopolistic competition, the demand curve is downward sloping, but still fairly elastic.  The optimum quantity to produce is where marginal revenue and marginal cost meet.  The price is determined from the demand curve.  If the average cost curve is below the demand curve then economic profits are obtained (short-run profit).  If the average cost curve meets the demand curve, then normal profits are realized (long-run equilibrium).

In an oligopoly, the point of deflection in the demand curve is where other firms will match any decrease in price (ie. a price war).  The kink in the demand curve is the current market price and occurs where the marginal revenue and marginal cost curves cross.  When the average cost is below the demand curve, economic profits are realized.  Even if the marginal costs were to change (up or down) within the vertical portion of the marginal revenue curve, the price would still remain the same.

In a monopoly, the optimum profit is obtained at an output quantity where the marginal revenue and marginal cost meet.  This is a lower quantity and higher price than would occur in either an oligopoly or monopolistic competitive market.  The demand curve is steeper indicating a more inelastic demand.  Production output will always occur between the two breakeven points where the average cost curve crosses the demand (or average revenue) curve.  The socially optimum price is at the output quantity indicated where the marginal cost curve crosses the demand curve, representing a lower price and higher output than in an unregulated market and may result in losses or profits.  The fair return price is where the average cost curve meets the demand curve resulting in lower prices and higher output than in an unregulated market and always results in normal profits.