Perfect Competition, Monopolistic Competition, Oligopoly, and Pure Monopoly

An oligopoly and a monopoly are economic market structures that are characterized by the existence of imperfect competition. A monopoly is a market that consists of a single firm which produces goods that have no close substitutes.  Often, this market has many barriers to entry. An oligopoly market consists of a small number of firms that are relatively large firms which produce products that are similar but slightly different. Under oligopolies, there also exist some barriers to entry of other enterprises into the business.

Characteristics of a Monopoly

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

Characteristics of an Oligopoly

  • Profit maximization is a condition in this market.
  • Monopolies set their own prices.
  • Barriers to entry are high and only a few number of firms operate in the market.
  • Make abnormal profits in the long-run.
  • Products may be homogeneous.
  • A relatively small number of firms supply the market.

Perfect Competition

Perfect competition refers to a market that has many buyers and sellers, many similar products and many substitutes.

Characteristics of Perfect Competition

  • There exist a very large number of buyers and sellers: This means that there are a large number of consumers who are both willing and able to buy the products at their fixed prices. There also are a large number of sellers who have the ability and willingness to supply their products at given market prices.
  • Perfect information: Every consumer and producer is aware of the market prices, and the utility derived from the use of any of the products.
  • Homogeneous products: The products being sold in this market are perfect substitutes to each other. The quality and characteristics don’t vary from each other.
  • Property rights are well defined.
  • Zero transaction costs.
  • No externalities.
  • Non-increasing returns to scale due to lack of economies of scale.
  • Profit maximization of sellers.
  • No single seller/producer is large enough to influence the market price.

Monopolistic Competition

This is an imperfect competition such that several producers sell products differentiated from each other. The difference is brought by branding, or in most cases, quality. This means the goods are not perfect substitutes to each other, but they are close substitutes. An example of this can be clothing, where marketing and branding is the main differentiator between different apparently similar black shirts.

monopolistic_competition

Characteristics of Monopolistic Competition

  • There are many producers and consumers in the market. There is no business that has total control over the price of the market.
  • Consumers assume that there are non-price differences among the products of competitors.
  • Barriers to entry and exit of firms exist but are few.
  • Producers have some control over the prices.
  • Producers and consumers have no perfect information.

Question

An industry is made up of four firms. These firms produce products that are easily replaceable. There are low 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 4 firms in the industry, there are low barriers to entry and the products can easily be replaced (no branding or quality constraints). Firms voluntarily choose not to enter the market.

Reading 15 LOS 15a:

describe characteristics of perfect competition, monopolistic competition, oligopoly, and pure monopoly

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