How do perfectly competitive and monopolistically competitive firms behave in the short and long run?
Perfect competition and monopolistic competition: their assumptions and characteristics, short-run and long-run equilibrium, the role of entry and exit, and the efficiency of each market structure.
An Eduqas A520 answer to the two more competitive market structures, covering the assumptions of perfect competition and monopolistic competition, short-run and long-run equilibrium, how free entry and exit competes away supernormal profit, and the allocative, productive and dynamic efficiency of each.
Reviewed by: AI editorial process; not yet individually human-reviewed
Have a quick question? Jump to the Q&A page
Jump to a section
What this dot point is asking
Eduqas wants you to state the assumptions of perfect competition and monopolistic competition, draw and explain their short-run and long-run equilibria, show how free entry and exit drives the long-run outcome, and evaluate the efficiency of each. These are the two more competitive structures; the next topic covers the two with more market power.
Perfect competition: assumptions
These are strong assumptions rarely met in full, but markets such as some agricultural commodities and foreign exchange approximate them.
Perfect competition: short run and long run
In the short run the firm produces where and may earn:
- Supernormal profit if price exceeds average total cost at that output;
- Normal profit if price equals average total cost; or
- A loss (but continues if price covers average variable cost).
Monopolistic competition
Examples include hairdressers, restaurants, plumbers and coffee shops: many competitors, but each with a distinct offer.
Comparing efficiency
- Allocative efficiency (): achieved by perfect competition in the long run; not by monopolistic competition ().
- Productive efficiency (minimum average cost): achieved by perfect competition; not by monopolistic competition (excess capacity).
- Dynamic efficiency (innovation over time): weak in perfect competition (no supernormal profit to fund research and development); monopolistic competition has some, through product differentiation and branding.
- Choice and variety: very limited in perfect competition (homogeneous product); a key benefit of monopolistic competition.
Examples in context
- Commodity markets. Wholesale wheat and foreign exchange approximate perfect competition: identical product, many traders, price-takers.
- High-street services. Coffee shops, salons and takeaways are textbook monopolistic competition, differentiated but with easy entry.
- App stores. Thousands of differentiated apps with low entry barriers compete profits toward normal levels, illustrating long-run monopolistic competition.
Try this
Q1. Explain why a perfectly competitive firm faces a perfectly elastic demand curve. [4 marks]
- Cue. It is one of many selling an identical product, so it cannot raise price (buyers switch) and need not lower it; it is a price-taker, hence horizontal demand at the market price.
Q2. Explain what is meant by excess capacity in monopolistic competition. [4 marks]
- Cue. In long-run equilibrium the firm produces on the falling part of the ATC curve, below the output that minimises average cost, so it could produce more at lower unit cost.
Exam-style practice questions
Practice questions written in the style of WJEC Eduqas exam questions on this dot point, with worked answer explainers. The year tag is the paper they imitate, not the source.
Eduqas Component 1 20192 marksState two characteristics of a perfectly competitive market.Show worked answer →
A 2-mark knowledge question, one mark per valid characteristic.
Acceptable answers include: a large number of buyers and sellers; a homogeneous (identical) product; freedom of entry and exit; perfect information; and firms are price-takers. Any two earn the marks.
Markers reward precise terms (for example "homogeneous product" and "price-taker") rather than vague phrases like "lots of competition". Naming the same idea twice scores once.
Eduqas Component 3 (micro) 202012 marksEvaluate the view that perfect competition leads to a better outcome for consumers than monopolistic competition.Show worked answer →
A levels-of-response essay. Knowledge and application: contrast the two structures. In long-run perfect competition firms produce where minimum ATC, so they are both allocatively and productively efficient and earn only normal profit. In monopolistic competition firms have some price-setting power (differentiated products), so in the long run they produce where on the falling part of the ATC curve (excess capacity), again earning only normal profit. Draw both diagrams.
Analysis: develop why perfect competition gives lower prices and full efficiency.
Evaluation: weigh the benefits of monopolistic competition (variety, choice, branding and some innovation) and note that perfect competition is a theoretical model rarely seen in reality, and that its lack of supernormal profit limits dynamic efficiency. Conclude with a supported judgement.
Related dot points
- Costs, revenues and profit: fixed and variable costs, marginal, average and total cost and revenue, the law of diminishing returns, normal and supernormal profit, and the profit-maximising condition.
An Eduqas A520 answer to business costs, revenues and profit, covering fixed and variable costs, the relationship between marginal, average and total measures, the law of diminishing returns, the distinction between normal and supernormal profit, and the profit-maximising rule that marginal revenue equals marginal cost.
- Oligopoly and monopoly: concentration and barriers to entry, interdependence and collusion in oligopoly, the kinked demand curve and game theory, monopoly equilibrium, price discrimination, and the costs and benefits of monopoly.
An Eduqas A520 answer to the two market structures with the most market power, covering concentration and barriers to entry, oligopolistic interdependence, collusion, the kinked demand curve and game theory, the profit-maximising monopoly, price discrimination, and the costs and benefits of monopoly power.
- Economies and diseconomies of scale and business growth: internal and external economies of scale, the minimum efficient scale, the causes of diseconomies of scale, and organic versus integrated growth and the divorce of ownership from control.
An Eduqas A520 answer to economies of scale and business growth, covering internal and external economies of scale, the long-run average cost curve and minimum efficient scale, the causes of diseconomies of scale, organic and integrated growth (mergers and takeovers), and the principal-agent problem.
- Monopoly power and inequality as market failures: the welfare costs of monopoly power, factor immobility, the distinction between equity and equality, and the measurement of inequality using the Lorenz curve and Gini coefficient.
An Eduqas A520 answer to monopoly power and inequality as causes of market failure, covering the welfare costs of monopoly and the abuse of market power, factor immobility, the difference between equity and equality, and how inequality is measured with the Lorenz curve and the Gini coefficient.
Sources & how we know this
- Eduqas A Level Economics Specification (A520) — Eduqas (2015)