Perfect Competition, Monopolistic Competition, Oligopoly, and Pure Monopoly

Market structure can be defined as the characteristics of a market, which can either be competitive or organizational. Moreover, market structure outlines the nature of the competition and the pricing procedure in a market. Therefore, it describes the number of entities producing similar goods and services in a market, and whose structure is determined by the current competition in the market.

There are four types of economic market structures (organized form the least competitive to the most competitive):

1. monopoly;
2. oligopoly;
3. monopolistic competition; and
4. perfect competition.

Monopoly

A monopoly is a market that consists of a single firm that produces goods that have no close substitutes. Often, this market has many entry barriers. For instance, water providers, natural gas, telecommunications, and electricity are often granted exclusive rights to service.

Characteristics of a Monopoly

• A monopoly is a profit maximizer.
• Monopolies are price makers.
• Price discrimination: monopolies can change both the price and quality of their products.
• There are very high barriers to entry for other firms.
• There is a single seller that controls the whole market.
• Pure monopolies are regulated by the government.

Oligopoly

An oligopoly market consists of a small number of relatively large firms that produce similar but slightly different products. Under oligopolies, there also exist some entry barriers with which other enterprises have to contend. Good examples include industries such as oil & gas, airline, and automakers.

Characteristics of an Oligopoly

• Only a few firms operate in the market.
• Profit maximization is a condition in this market.
• Monopolies set their own prices.
• Barriers to entry are high.
• Firms make abnormal profits in the long-run.
• Products may be homogeneous.
• There is a relatively small number of firms supplying the market.

Monopolistic Competition

This is an imperfect competition in which several producers sell products that are different from one another. The difference lies in branding or, in most cases, quality. This means that the goods are not perfect substitutes for one another, but they are close substitutes. An example of this can be clothing, where marketing and branding are the main marks of distinction among different but apparently similar black shirts. Another example would be the fast-food industry, where a burger made by McDonald’s is quite similar to a burger made by Burger King from an economic standpoint. Consumers, nevertheless, usually have a preference between the two chains.

Characteristics of Monopolistic Competition

• There are many producers and consumers in the market.
• There is not one firm that has total control over the price of the market.
• Consumers assume that there are non-price differences among the products of competitors.
• Few barriers to entry and exit exist.
• Producers have some control over prices.
• Producers and consumers have no perfect information.

Perfect Competition

Perfect competition refers to a market that has many buyers and sellers, many similar products, and many substitutes. A good example is agriculture, where all rice farmers sell homogeneous products to consumers.

Characteristics of Perfect Competition

• There exist a very large number of buyers.
• There exist a very large number of sellers willing to supply their products at given market prices.
• No single seller or producer is large enough to influence the market price.
• Homogeneous products: the products being sold in this market are perfect substitutes for one another. Their quality and characteristics don’t vary from one another.
• Perfect information: every consumer and producer is aware of the market prices and the utility derived from the use of any of the products.
• There are no entry barriers.

Question

An industry is made up of twenty firms. These firms produce products that easily complement one another and there are no barriers to entry. This industry can be best characterized as:

A. An oligopoly

B. A monopolistic competition.

C. Perfect competition.

Solution

The correct answer is C.

Even though there are only twenty firms in the industry, there are no barriers to entry and the products can easily complement one another (no branding or quality constraints). Firms voluntarily choose not to enter the market.

Option A is incorrect. In an oligopoly, barriers to entry are high.

Option B is incorrect. In monopolistic competition, barriers to entry and exit exist.