The way in which firms are structured in an industry and the way they compete with each other are often described using the following terms:
A perfectly competitive market has many firms producing the same (ie homogeneous) goods or services. The market is easy to enter and exit. Under perfect competition producers and consumers have all the information they require they have ‘perfect knowledge’ of the market.
The price and level of output under perfect competition tends towards the equilibrium point. Producers attempting to sell at a higher price will not sell anything, and producers attempting to sell as a price below equilibrium would obtain 100% market share.
The demand ‘curve’ is horizontal it is ‘perfectly elastic’. There are few if any truly perfectly competitive markets in the real world. Some financial markets in which information is freely available are probably as close as we get to a perfectly competitive market.
The term ‘imperfect competition’ applies to any market that is not perfect. As we explained above, almost all markets are imperfect, although the degree to which they are imperfect can vary significantly.
A monopoly describes the situation where a market has only one producer. That is the pure definition, although the term is often used to describe a firm that has a very high share of a market.
A monopoly may come about because the producer has a statutory right to be the only producer, perhaps a ‘state owned enterprise’. If left uncontrolled, a monopoly can set its own price in the market place, which can result in what economists refer to as ‘super-normal profits’. For this reason, monopolies are usually subject to control by government or a government agency.
An oligopoly arises when a market has a few dominant producers. Each of the few producers has a high level of influence and a high level of knowledge of their competitor strategies. If an oligopoly has only two firms, it is referred to as a duopoly.
Oligopolistic markets are often characterized by complex product differentiation, significant barriers to entry and a high level of influence on prices.
An example of an oligopoly is the retail petrol and diesel market several large companies including Exxon Mobil, Shell and BP control the majority of the market (although fuel outlets linked to supermarket are gaining market-share).
An example of a duopoly would be the two major cola producers, Coca-Cola and Pepsi.
Monopolistic competition arises when the market comprises many producers who tend to use product differentiation to distinguish themselves from others. Although their products may be very similar, because producers differentiate their products they are able to create a short-term ‘monopoly’, as customers see their product as unique.
Therefore, for monopolistic competition to exist, consumers must perceive differences in the products offered by different firms. Monopolistic competition tends to have fewer barriers to entry or exit than oligopolistic competition.