Unit 4 Test: Imperfect Competition
Test AP Microeconomics Unit 4 concepts — monopoly deadweight loss, monopolistic competition excess capacity, oligopoly game theory, and Nash equilibrium practice.
Market Structures Beyond Perfect Competition
Unit 4 examines what happens when firms have market power — the ability to influence price. AP Microeconomics tests three imperfect market structures: monopoly, monopolistic competition, and oligopoly. Each has a distinct graphical model and set of behavioral assumptions that appear frequently in both MCQ and FRQ sections.
Key Topics in Unit 4
Monopoly
A monopolist is the sole seller in a market. Because it faces a downward-sloping demand curve, marginal revenue (MR) is less than price — a critical distinction from perfect competition. The monopolist maximizes profit where MR = MC and then looks up to the demand curve to set the price. Key AP analysis points include:
- Drawing the monopoly graph with demand, MR, MC, and ATC correctly positioned.
- Identifying the profit-maximizing output and the price charged.
- Shading the profit rectangle and the deadweight loss triangle (lost surplus compared to competitive outcome).
- Understanding price discrimination: a monopolist can increase profit by charging different prices to different consumer groups based on willingness to pay.
Monopolistic Competition
Monopolistically competitive firms sell differentiated products and face a downward-sloping demand curve, but free entry eliminates economic profit in the long run. Short-run analysis mirrors monopoly (profit or loss possible). In long-run equilibrium, price equals ATC but is above MC, resulting in excess capacity — the firm produces less than the output at minimum ATC. AP questions ask students to draw both the short-run and long-run equilibria.
Oligopoly and Game Theory
Oligopolies are markets dominated by a few interdependent firms. Each firm must anticipate the reactions of rivals. AP Microeconomics focuses on game theory concepts rather than graphical models for oligopoly. Key concepts include:
- Dominant strategy: a strategy that is optimal regardless of what the rival does.
- Nash equilibrium: a situation where no firm can improve its outcome by unilaterally changing its strategy.
- Prisoner's dilemma: a scenario where individually rational choices lead to a collectively worse outcome, commonly applied to firms deciding whether to collude or compete.
Comparing Market Structures
AP exams frequently ask students to compare outcomes across market structures. A useful framework:
- Perfect competition: P = MC = minimum ATC in long run. Allocatively and productively efficient.
- Monopoly: P greater than MC, deadweight loss, no entry.
- Monopolistic competition: P = ATC but P greater than MC in long run, excess capacity.
- Oligopoly: outcome depends on strategic interaction; may approach competitive or monopoly outcome.
AP Graph Skills for Unit 4
- Draw the monopoly diagram with MR below demand, MR = MC profit-maximizing output, and deadweight loss triangle.
- Draw short-run profit and long-run zero-profit diagrams for monopolistic competition.
- Interpret a payoff matrix to identify dominant strategies and Nash equilibria.