Economists have identified four types of competition – perfect competition, monopolistic competition, oligopoly, and monopoly.
In this lesson, we will discuss each of these four types of competition in greater detail.
A perfectly competitive market is a hypothetical market where competition is at its greatest possible level. It a perfect competition market, there are a large number of buyers and sellers. All the sellers of the market are small firms competing against each other. There is no one big seller with any significant influence on the market. As a result, the industry as a whole produces the socially optimal level of output, because none of the firms can influence market prices.
Probably the best example of a market with an almost perfect competition we can find in reality is the stock market.
In monopolistic competition, there are many sellers and buyers but not all sellers sell identical products. The products are similar but all sellers sell slightly differentiated products. Products are differentiated in a number of ways, including quality, style, convenience, location, and brand name. The consumers have the preference of choosing one product over another. That gives the sellers a certain degree of market power, which allows them to charge higher prices within a certain range.
For example, the market for cereals is a monopolistic competition. Most of them probably taste slightly different, but at the end of the day, they are all breakfast cereals.
Product differentiation either happens due to geographical reasons like buying from a store closest to the home regardless of the brand or at other times, advertising promotes the perceived differences between products. If the product price goes too high, the seller loses business to a competitor. Under monopolistic competition, therefore, companies have only limited control over price.
This is a more realistic scenario in the real world. Monopolistic competition builds on the following assumptions:
Now, those assumptions are a bit closer to reality than the ones we looked at in perfect competition. However, these market competition no longer results in a socially optimal level of output because the firms have more power and can influence market prices to a certain degree.
It means a 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. As products are fairly similar, when one company lowers prices, others are often forced to follow suit to remain competitive. For example, when one airline announces a fare decrease, the other airlines do likewise; or 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.
Most monopolies fall into one of two categories:
