Difficulty: Medium
Correct Answer: (a) Monopolistic competition, (b) Pure competition
Explanation:
Introduction / Context:
Different market structures have distinct relationships between price and marginal cost and face different shapes of demand curves. In perfect competition, each firm is a price taker and faces a perfectly elastic demand curve, so price equals marginal cost in equilibrium. In monopolistic competition and monopoly, firms have some degree of market power, so price is greater than marginal cost in both the short run and the long run. This question asks you to match two specific characteristics with the correct market structures, testing your understanding of how price, marginal cost, and demand elasticity vary across market types.
Given Data / Assumptions:
Concept / Approach:
In pure competition, each firm takes the market price as given and can sell as much as it wants at that price. The demand curve facing an individual competitive firm is perfectly elastic, and in equilibrium, price equals marginal cost (P = MC). In monopolistic competition, each firm faces a downward sloping demand curve and has some pricing power; therefore, price is greater than marginal cost (P > MC) in both the short run and the long run. The demand curve is elastic but not perfectly elastic. Monopoly also has P > MC, but its demand is usually less elastic than in monopolistic competition. The question states that price exceeds marginal cost in both periods for (a), which fits monopolistic competition or monopoly, and that the firm for (b) faces a highly elastic demand curve, which best fits pure competition. Therefore, the correct matching is (a) monopolistic competition, (b) pure competition.
Step-by-Step Solution:
Step 1: Focus on characteristic (a): Price greater than marginal cost in both short run and long run.Step 2: Recognise that in perfect competition, price equals marginal cost in equilibrium, so pure competition cannot satisfy characteristic (a).Step 3: Note that monopolistic competition and monopoly both have some market power, so price exceeds marginal cost in both short run and long run.Step 4: Now consider characteristic (b): the firm faces a highly elastic demand curve.Step 5: In pure competition, each firm faces a perfectly elastic (that is, infinitely elastic) demand curve at the market price.Step 6: In monopolistic competition, demand is downward sloping but relatively elastic, not perfectly elastic; in monopoly, demand is typically less elastic.Step 7: Therefore, the best fit is (a) monopolistic competition (P > MC both periods) and (b) pure competition (highly elastic demand), which corresponds to option A.
Verification / Alternative check:
We can cross check each alternative. Option B pairs (a) with pure monopoly, which does have P > MC, but it pairs (b) with monopolistic competition, where demand is not as highly elastic as under pure competition. Option C claims (a) pure competition, which is incorrect because in pure competition P = MC. Option D links (a) oligopoly, where behaviour depends on the model and is not uniquely described by the condition, and (b) pure competition, but it still leaves (a) poorly matched. Only option A gives a logically consistent pair. Monopolistic competition exhibits P > MC in the long run due to product differentiation and downward sloping demand, and pure competition exhibits the highest elasticity of demand at the firm level.
Why Other Options Are Wrong:
Option B is wrong because it assigns the highly elastic demand curve to monopolistic competition rather than pure competition, which is an overstatement of the elasticity. Option C is incorrect because pure competition does not have P > MC; it has P = MC in equilibrium. Option D is problematic because it assigns characteristic (a) to oligopoly without clear justification, and while pure competition does have highly elastic demand, the pair does not handle (a) correctly. Only option A aligns both characteristics with the correct market structures.
Common Pitfalls:
A common mistake is to assume that any imperfectly competitive market necessarily faces an elastic demand curve, but elasticity is relative. Pure competition has a perfectly elastic demand curve at the firm level, while monopolistic competition has a moderately elastic but downward sloping curve. Another pitfall is forgetting that in the long run, monopolistic competition still has P > MC because of product differentiation, even though firms earn only normal profit. Keeping track of both the P versus MC relationship and the shape of the demand curve helps avoid confusion.
Final Answer:
The correct matching is (a) Monopolistic competition, (b) Pure competition.
Discussion & Comments