Economics Test Out Practice Test

Firms can differentiate their products, and there are many of them, so each firm has some ability to set its price rather than taking the market price as given. That means the firm faces a downward-sloping demand curve: if it raises its price a bit, some customers switch, but not all, because they value the unique features, branding, or quality of its product. This combination—many firms plus product differentiation—gives firms some price control, which is why this structure is characterized by a degree of market power. In the short run, a firm can earn above-normal profits, but in the long run easy entry and exit erode those profits, pushing the typical outcome toward zero economic profit while still allowing a price above marginal cost and some excess capacity. In contrast, perfect competition has identical products and no price-setting power; monopoly has a single seller with strong price power; and an oligopoly involves few firms with strategic interactions, which is a different source and shape of market power.