All 6 Micro units
🪙
AP Microeconomics · Unit 4 of 6

Imperfect Competition

15–22% of the exam9 lessons · 124 min48 terms
Cram this unit Flip through the cards Sit a unit test Math practice

What this unit covers

The topics below follow the published Micro course framework for Unit 4. This unit is worth 15–22% of the exam, so budget your time against that rather than against how long the unit takes to teach.

MonopolyOligopolyGame theoryMonopolistic competition

Lessons in this unit

Formulas in Unit 4

Monopoly pricing
Profit-max: MR = MC, then set price from demand: P > MR = MC · Allocative efficiency would require P = MC
Because P > MC at the monopoly output, output is below the efficient level, creating deadweight loss. For linear demand, MR has the same intercept but twice the slope.
Long-run equilibrium features
MR = MC (profit-max) · Zero economic profit (P = ATC, tangency) · P > MC (inefficient) · excess capacity
Like monopoly: downward-sloping demand, MR < P, P > MC. Like perfect competition: easy entry drives long-run profit to zero. Unlike perfect competition: not at minimum ATC.
Reading the game
Dominant strategy: best choice no matter what the rival does · Nash equilibrium: no player gains by changing strategy alone
Analyze one firm at a time: fix the rival’s choice, pick this firm’s best response. Where both firms’ best responses coincide is the Nash equilibrium.
Marginal revenue for a linear demand curve
if P = a − bQ then MR = a − 2bQ
Same intercept, twice the slope. So MR hits zero at exactly half the quantity where demand hits zero — a useful graphing shortcut.
The deadweight loss triangle
bounded by: demand above, MC below, from Q_monopoly to Q_socially optimal
Its height at the monopoly quantity is the gap between price and marginal cost. Zero deadweight loss requires P = MC, which only perfect competition delivers.
Perfect price discrimination
each unit sold at the maximum any buyer will pay → MR curve becomes the DEMAND curve → produces where D = MC
Output rises to the allocatively efficient quantity and deadweight loss disappears — but the entire consumer surplus is captured by the producer.
The two regulated prices
socially optimal (marginal-cost) pricing: P = MC — allocatively efficient, but the firm loses money · fair-return (average-cost) pricing: P = ATC — firm breaks even, but P > MC so some deadweight loss remains
Because ATC is falling, MC lies BELOW ATC throughout. So P = MC necessarily means P < ATC and a loss.
The long-run condition
P = ATC (zero profit, from free entry) but P > MC (from downward-sloping demand) and ATC is NOT at its minimum
Compare perfect competition, where P = MC = minimum ATC. Monopolistic competition achieves zero profit without achieving either efficiency.
The two definitions
dominant strategy: best for a player NO MATTER what the other does · Nash equilibrium: a cell where NEITHER player can improve by unilaterally switching
A dominant strategy need not exist. A Nash equilibrium almost always does, and there can be more than one.

Every term in Unit 4

All 48 terms we publish for Imperfect Competition, with definitions. Reading them through is the fastest way to find the ones you cannot define — then drill those in cram mode until you can produce them without the prompt.

Price Discrimination
Charging different prices to different consumers for the exact same good (e.g., student discounts). Requires market power and inability to resell. Converts consumer surplus into profit.
Monopoly
A single seller of a product with no close substitutes, protected by barriers to entry. The firm is the industry, so it faces the market demand curve.
Barriers to entry
Economies of scale, control of a key resource, patents and licenses, and legal restrictions. Without a barrier, monopoly profit attracts entry and the monopoly ends.
Why MR lies below demand for a monopolist
To sell one more unit the monopolist must lower the price on every unit, so the revenue gained on the last unit is offset by revenue lost on the rest.
MR curve of a linear monopolist
Same vertical intercept as demand, twice the slope — so it hits the horizontal axis at half the quantity where demand does.
Monopoly output and price
Produce where MR = MC, then read the price up on the demand curve. Reading price off the MR curve is the most common single error in this unit.
Monopoly deadweight loss
The monopolist restricts output below the point where P = MC, so mutually beneficial trades go unmade. The triangle between demand and MC over the missing units.
Why a monopoly is allocatively inefficient
At its chosen quantity, price exceeds marginal cost, so the value of another unit to buyers exceeds its cost to produce.
Why a monopoly is productively inefficient
It does not produce at minimum ATC, because there is no entry to compete the price down to that point.
Monopoly in the long run
Barriers to entry mean economic profit can persist indefinitely. This is the sharpest contrast with perfect competition.
Natural monopoly
A market where economies of scale extend over the whole relevant range, so one firm can supply at lower average cost than several. Utilities are the standard example.
Socially optimal price regulation
Set price where P = MC. Allocatively efficient, but for a natural monopoly it sits below ATC, so the firm makes a loss and needs a subsidy to survive.
Fair-return price regulation
Set price where P = ATC. The firm earns normal profit and stays solvent, but output is still below the allocatively efficient level.
Perfect price discrimination
Every buyer is charged exactly their willingness to pay. Consumer surplus is entirely captured as profit, deadweight loss is zero, and output equals the competitive level.
Monopolistic competition
Many firms, differentiated products, and easy entry and exit. Firms have some price-setting power, so demand slopes downward, but profits are competed away in the long run.
Long-run equilibrium in monopolistic competition
Entry continues until demand is tangent to ATC, so P = ATC and economic profit is zero. But P > MC and output is below minimum ATC.
Excess capacity
The tangency falls on ATC's declining portion, so output is below minimum-ATC output. The firm could produce more cheaply per unit and does not.
Monopolistic competition vs perfect competition
Both reach zero economic profit in the long run. Monopolistic competition is neither productively nor allocatively efficient, because the demand curve it faces slopes downward.
Oligopoly
A few large firms whose decisions are interdependent — each must anticipate the others' responses. This interdependence is what makes game theory the right tool.
Concentration ratio
The combined market share of the largest few firms. A rough measure of how oligopolistic an industry is.
Collusion
Firms agreeing to restrict output and raise prices toward the monopoly outcome. Illegal in most jurisdictions and unstable, because each member gains by cheating.
Cartel
A formal collusive agreement, such as OPEC. It faces the same instability: the agreement is profitable collectively and each member individually gains from breaking it.
Payoff matrix
A table of each firm's payoff for every combination of strategies. Read one player's payoffs holding the other's strategy fixed — that is how a dominant strategy is found.
Dominant strategy
A strategy that gives a higher payoff regardless of what the other player does. Not every game has one for either player.
Nash equilibrium
An outcome where neither player can improve by unilaterally changing strategy. It need not be the best joint outcome — which is exactly the prisoner's dilemma point.
Prisoner's dilemma
A game where each player's dominant strategy produces an outcome both would rather avoid. The model for why cartels break down.
Simultaneous vs sequential games
In simultaneous games players choose without knowing the other's move, and the matrix is the right tool. Sequential games use a decision tree and are solved backward.
Game theory in oligopoly
Explains price rigidity, tacit collusion and price wars as equilibrium outcomes rather than irrationality. Expect a two-by-two matrix and a Nash equilibrium question.
Comparing the four market structures
Number of firms, product differentiation, barriers to entry, price-setting power, and long-run profit. Only perfect competition achieves both efficiencies; only monopoly and oligopoly sustain long-run profit.
Where MR = MC applies
All four structures. What differs is whether MR equals price — it does only under perfect competition, which is why every other structure has P > MC.
Why MR lies below price
Selling one more unit requires cutting the price on ALL units, so MR is the new unit's price minus the revenue lost on the earlier ones.
MR for a linear demand curve
If P = a − bQ then MR = a − 2bQ: same intercept, twice the slope. So MR bisects the horizontal distance to the quantity axis.
MR and elasticity
MR positive where demand is elastic, zero at unit elastic (revenue maximized), negative where inelastic. A profit maximizer always operates on the elastic portion.
Where to read the monopoly price
Quantity from MR = MC, then go UP to the DEMAND curve for the price. Reading the price off MR is the classic error on this graph.
Where the deadweight loss triangle sits
Between the monopoly quantity and where demand crosses MC, bounded by demand above and MC below. Not ATC.
Transfer versus deadweight loss
The rectangle from consumers to the producer is a redistribution — somebody receives it. Only the triangle is destroyed. Different objections.
Why monopoly fails both efficiencies
P > MC fails allocative efficiency; producing above minimum ATC fails productive efficiency. Perfect competition achieves both.
Two real arguments for monopoly
Natural monopoly, where scale economies make one firm cheapest. And innovation incentives, which is why patents deliberately create temporary monopolies.
Three conditions for price discrimination
Market power, ability to segment by willingness to pay, and prevention of resale. Remove any one and the strategy collapses.
Perfect price discrimination is efficient
MR becomes the demand curve, so output reaches the socially optimal quantity and deadweight loss is zero — but all consumer surplus is captured.
Cost-based pricing is not discrimination
A first-class seat costs more to provide. Discrimination means different prices for the SAME good at the SAME cost.
Natural monopoly geometry
ATC falls across the whole relevant range, so MC lies BELOW ATC throughout. This is why P = MC necessarily means a loss.
The two regulated prices
Socially optimal P = MC: allocatively efficient but loss-making, needing a subsidy. Fair-return P = ATC: breaks even but leaves residual deadweight loss.
Monopolistic competition long-run tangency
Demand is TANGENT to ATC, so P = ATC and profit is zero. Tangency rather than crossing is what makes profit exactly zero.
What entry does to a differentiated firm
Demand shifts LEFT and becomes MORE elastic — fewer customers, more substitutes. It never becomes perfectly elastic, since differentiation persists.
Dominant strategy vs Nash equilibrium
Dominant: best regardless of the opponent. Nash: a cell nobody can improve on by switching alone. A dominant strategy may not exist; a Nash equilibrium usually does.
Nash is not the highest joint payoff
It is the STABLE cell. The prisoner's dilemma equilibrium is stable and jointly worse than cooperation, which is exactly the point.
Why cartels break down
Exceeding the quota is individually profitable whatever others do — a dominant strategy. So the agreement collapses without enforcement.

What examiners penalize here

Practice Micro

Our practice bank is drawn from across the whole course rather than filtered to one unit, which is closer to how the exam asks anyway — it will not tell you which unit a question is testing.

84 practice questionsEvery one with a written explanationFRQ trainerWritten answers scored against the rubricMicro study guideAll units, weights and score data in one placeAll 6 Micro unitsThe full course

Questions about this unit

How much of the AP Microeconomics exam is Unit 4?

Unit 4, Imperfect Competition, is worth 15–22% of the Micro multiple-choice section according to the published course framework. Across all 6 units that makes it one of the heaviest units on the exam, and worth front-loading.

What topics are covered in Micro Unit 4?

Imperfect Competition covers Monopoly, Oligopoly, Game theory and Monopolistic competition. We publish 48 terms with definitions for this unit, all of them on this page.

How should I study Micro Unit 4?

Read the 9 lessons below first — about 125 minutes — then drill the 48 terms in cram mode until you can produce each definition from memory rather than just recognize it. Recognition is what makes a unit feel finished when it is not. Finish with practice questions and read the explanation for every one you get right by elimination as well as the ones you miss.

All 6 units of AP Microeconomics

  1. Unit 1 · Basic Economic Concepts
  2. Unit 2 · Supply & Demand
  3. Unit 3 · Production, Cost & Perfect Competition
  4. Unit 4 · Imperfect Competition
  5. Unit 5 · Factor Markets
  6. Unit 6 · Market Failure & Government

Unit names, topics and exam weights follow the published College Board course framework for AP Microeconomics. AP® is a trademark registered by the College Board, which does not endorse this site.