Economists have identified four types of competition—perfect competition, monopolistic competition, oligopoly, and monopoly. Perfect competition was discussed in the last section; we’ll cover the remaining three types of competition here.
In monopolistic competition, we still have many sellers [as we had under perfect competition]. Now, however, they don’t sell identical products. Instead, they sell differentiated products—products that differ somewhat, or are perceived to differ, even though they serve a similar purpose. Products can be differentiated in a number of ways, including quality, style, convenience, location, and brand name. Some people prefer Coke over Pepsi, even though the two products are quite similar. But what if there was a substantial price difference between the two? In that case, buyers could be persuaded to switch from one to the other. Thus, if Coke has a big promotional sale at a supermarket chain, some Pepsi drinkers might switch [at least temporarily].
How is product differentiation accomplished? Sometimes, it’s simply geographical; you probably buy gasoline at the station closest to your home regardless of the brand. At other times, perceived differences between products are promoted by advertising designed to convince consumers that one product is different from another—and better than it. Regardless of customer loyalty to a product, however, if its price goes too high, the seller will lose business to a competitor. Under monopolistic competition, therefore, companies have only limited control over price.
Oligopoly means few sellers. In an oligopolistic market, each seller supplies a large portion of all the products sold in the marketplace. In addition, because the cost of starting a business in an oligopolistic industry is usually high, the number of firms entering it is low.
Companies in oligopolistic industries include such large-scale enterprises as automobile companies and airlines. As large firms supplying a sizable portion of a market, these companies have some control over the prices they charge. But there’s a catch: because products are fairly similar, when one company lowers prices, others are often forced to follow suit to remain competitive. You see this practice all the time in the airline industry: When American Airlines announces a fare decrease, Continental, United Airlines, and others do likewise. When one automaker offers a special deal, its competitors usually come up with similar promotions.
In terms of the number of sellers and degree of competition, monopolies lie at the opposite end of the spectrum from perfect competition. In perfect competition, there are many small companies, none of which can control prices; they simply accept the market price determined by supply and demand. In a monopoly, however, there’s only one seller in the market. The market could be a geographical area, such as a city or a regional area, and doesn’t necessarily have to be an entire country.
There are few monopolies in the United States because the government limits them. Most fall into one of two categories: natural and legal. Natural monopolies include public utilities, such as electricity and gas suppliers. Such enterprises require huge investments, and it would be inefficient to duplicate the products that they provide. They inhibit competition, but they’re legal because they’re important to society. In exchange for the right to conduct business without competition, they’re regulated. For instance, they can’t charge whatever prices they want, but they must adhere to government-controlled prices. As a rule, they’re required to serve all customers, even if doing so isn’t cost efficient.
A legal monopoly arises when a company receives a patent giving it exclusive use of an invented product or process. Patents are issued for a limited time, generally twenty years [United States Patent and Trademark Office, General Information Concerning Patents, April 15, 2006, [accessed January 21, 2012].
Monopolistic competition exists when many companies offer competitive products or services that are similar, but not exact, substitutes. Hair salons and clothing are examples of industries with monopolistic competition. Pricing and marketing are key strategies for competing companies and often rely on branding or discount pricing strategies to increase market share.
A monopolistic market and a perfectly competitive market are two market structures that have several key distinctions in terms of market share, price control, and barriers to entry. In a monopolistic market, there is only one firm that dictates the price and supply levels of goods and services, and that firm has total market control. In contrast to a monopolistic market, a perfectly competitive market is composed of many firms, where no one firm has market control.
Monopolistic and perfectly competitive markets affect supply, demand, and prices in different ways. In the real world, no market is purely monopolistic or perfectly competitive. Every real-world market combines elements of both of these market types.
Key Takeaways:
- In a monopolistic market, there is only one firm that dictates the price and supply levels of goods and services.
- A perfectly competitive market is composed of many firms, where no one firm has market control.
- In the real world, no market is purely monopolistic or perfectly competitive.
- In between a monopolistic market and perfect competition lies monopolistic competition or imperfect competition.
- In monopolistic competition, there are many producers and consumers in the marketplace, and all firms only have a degree of market control.
Monopolistic Markets
In a monopolistic market, firms are price makers because they control the prices of goods and services. In this type of market, prices are generally high for goods and services because firms have total control of the market. Firms have total market share, which creates difficult entry and exit points. Since barriers to entry in a monopolistic market are high, firms that manage to enter the market are still often dominated by one bigger firm.
A monopolistic market generally involves a single seller, and buyers do not have a choice concerning where to purchase their goods or services.
Purely monopolistic markets are extremely rare and perhaps even impossible in the absence of absolute barriers to entry, such as a ban on competition or sole possession of all natural resources. Sometimes, however, a government will establish a monopolistic market to ensure national interests or maintain critical infrastructure. For instance, many utilities such as power companies or water authorities may be granted a monopoly status for a certain area.
In the absence of such permission, governments often have laws and enforcement mechanisms to promote competition by preventing or breaking up monopolies. This is because a monopolistic market can often become inefficient, charge customers higher prices than would otherwise be available, and can prevent newcomers from entering the market. Thus, there are various antitrust regulations that keep monopolies at bay.
A monopoly is when there is only one seller in the market. A monopsony, on the other hand, is when there is only one buyer in a market.
Perfect Competition
In a market that experiences perfect competition, prices are dictated by supply and demand. Firms in a perfectly competitive market are all price takers because no one firm has enough market control. Unlike a monopolistic market, firms in a perfectly competitive market have a small market share. Barriers to entry are relatively low, and firms can enter and exit the market easily. Contrary to a monopolistic market, a perfectly competitive market has many buyers and sellers, and consumers can choose where they buy their goods and services.
Companies earn just enough profit to stay in business and no more. If they were to earn excess profits, other companies would enter the market and drive profits down. As mentioned earlier, perfect competition is a theoretical construct. As such, it is difficult to find real-life examples of perfect competition.
Pricing in perfect competition is based on supply and demand while pricing in monopolistic competition is set by the seller.
Special Considerations
According to economic theory, when there is perfect competition, the prices of goods will approach their marginal cost of production [i.e., the cost to produce one more unit]. This is because any firm that tries to sell at a higher price in an attempt to earn excess profits will be undercut by a competitor seeking to grab market share. This also promotes a sort of technological arms race in order to reduce the costs of production so that competitors can undercut one another and still earn a profit. Over time, however, as technology diffuses through to all producers, the effect is to lower consumer prices even further [as well as erode profits for producers].
In between a monopolistic market and perfect competition lies monopolistic competition. In monopolistic competition, there are many producers and consumers in the marketplace, and all firms only have a degree of market control. In contrast, whereas a monopolist in a monopolistic market has total control of the market, monopolistic competition offers very few barriers to entry. All firms are able to enter into a market if they feel the profits are attractive enough. This makes monopolistic competition similar to perfect competition.
However, in a monopolist competitive market, there is product differentiation. Products in monopolistic competition are close substitutes; the products have distinct features, such as branding or quality. This is unlike both a monopolistic market, where there are no substitutes for products, and perfect competition, where the products are identical.
In reality, all markets will display some form of imperfect competition. That is because there will always be some barriers to entry, some information asymmetries, larger and smaller competitors, and small differences in product differentiation.
What Are the Differences Between Monopolistic Markets and Perfect Competition?
In a monopolistic market, there is only one seller or producer of a good. Because there is no competition, this seller can charge any price they want [subject to buyers' demand] and establish barriers to entry to keep new companies out. On the other hand, perfectly competitive markets have several firms each competing with one another to sell their goods to buyers. In this case, prices are kept low through competition, and barriers to entry are low.
What Is the Difference Between a Monopoly and a Monopolistic Market?
A monopoly refers to a single producer or seller of a good or service. A monopolistic market is the scope of that monopoly. For instance, XYZ Co. may be a monopoly producer of widgets. It can control a monopolistic market over all the widgets sold in the United States whereby nobody else sells widgets.
What Are the Main Characteristics of Perfect Competition?
In a perfectly competitive market: all firms sell an identical product; all firms are price-takers; all firms have a relatively small market share; buyers know the nature of the product being sold and the prices charged by each firm; the industry is characterized by freedom of entry and exit. In reality, some or all of these features are not present or are influenced in some way, leading to imperfect competition.