Question

Select a specific real-world firm or market and discuss which model of market structure you think would be most appropriate to describe that market.

(ie. Perfect competition, monopolistic competition, oligopoly, monopoly.)

Real world markets never exactly meet the assumptions of the models, so you can also talk about what aspects of the real-world market may not fit the model what aspects are not well described by the model selected.

You might want to consider, if relevant in your case, factors such as: the nature of the product, factors about the production such as whether or not there are likely to be economies of scale, the number of competitors, the degree of market power, how firms compete, and outcomes such as prices, mark ups, profits and firm entry/exit.

Answer 1

5 Requirements of Perfect Competition

• 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.

Because these five requirements rarely exist together in any one industry, perfect competition is rarely (if ever) observed in the real world. For example, most products have some degree of differentiation. Even with a product as simple as bottled water, for example, producers vary in the method of purification, product size, brand identity, etc. Commodities such as raw agricultural products, although they can still differ in terms of quality, come closest to being identical, or having zero differentiation. When a product does come to have zero differentiation, its industry is usually concentrated into a small number of large firms or an oligopoly.

Barriers to Entry Prohibit Perfect Competition

Many industries also have significant barriers to entry, such as high startup costs (as seen in the auto manufacturing industry) or strict government regulations (as seen in the utilities industry), which limit the ability of firms to enter and exit such industries. And although consumer awareness has increased with the information age, there are still few industries where the buyer remains aware of all available products and prices.

As you can see, significant obstacles are preventing perfect competition from appearing in today's economy. The agricultural industry probably comes closest to exhibiting perfect competition because it is characterized by many small producers with virtually no ability to alter the selling price of their products. The commercial buyers of agricultural commodities are generally very well-informed and, although agricultural production involves some barriers to entry, it is not particularly difficult to enter the marketplace as a producer

Monopolistic Market

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 able 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 of 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.

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 allow firms to enter and exit easily. Contrary to a monopolistic market, a perfectly competitive market has many buyers and sellers, and consumers are able to 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

Monopolistic Competition

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, whereas a monopolist in a monopolistic market has total control of the market. Unlike a monopolistic 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.

Pricing in perfect competition is based on supply-demand, while pricing in monopolistic competition is set by the seller

• 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. Every real-world market combines elements of both of these ideal types.
• 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.

A real life example of a market that is close to perfect competition? Markets for many farm products and the stocks traded on the New York Stock Exchange. What are start-up costs for a new company? The expenses that a new business must pay before it can begin to produce and sell goods.

Oligopoly

An oligopoly describes a market structure that is dominated by only a small number of firms. That results in a state of limited competition. The firms can either compete against each other or collaborate (see also Cournot vs. Bertrand Competition). By doing so, they can use their collective market power to drive up prices and earn more profit.

The oligopolistic market structure builds on the following assumptions: (1) all firms maximize profits, (2) oligopolies can set prices, (3) there are barriers to entry and exit in the market, (4) products may be homogenous or differentiated, and (5) there is only a few firms that dominate the market. Unfortunately, it is not clearly defined what a “few firms“ means precisely. As a rule of thumb, we say that an oligopoly typically consists of about 3-5 dominant firms.

To give an example of an oligopoly, let’s look at the market for gaming consoles. This market is dominated by three powerful companies: Microsoft, Sony, and Nintendo. That leaves all of them with a significant amount of market power.

Monopoly

A monopoly refers to a market structure where a single firm controls the entire market. In this scenario, the firm has the highest level of market power, as consumers do not have any alternatives. As a result, monopolies often reduce output to increase prices and earn more profit.

The following assumptions are made when we talk about monopolies: (1) the monopolist maximizes profit, (2) it can set the price, (3) there are high barriers to entry and exit, (4) there is only one firm that dominates the entire market.

From the perspective of society, most monopolies are usually not desirable, because they result in lower outputs and higher prices compared to competitive markets. Therefore, they are often regulated by the government. An example of a real-life monopoly could be Monsanto. This company trademarks about 80% of all corn harvested in the US, which gives it a high level of market power. You can find additional information about monopolies in our post on monopoly power.

There are four basic types of market structures: perfect competition, imperfect competition, oligopoly, and monopoly. Perfect competition describes a market structure, where a large number of small firms compete against each other with homogenous products. Meanwhile, monopolistic competition refers to a market structure, where a large number of small firms compete against each other with differentiated products. An Oligopoly describes a market structure where a small number of firms compete against each other. And last but not least, a monopoly refers to a market structure where a single firm controls the entire market.

Real world example of market

• Pepsi During Fashion Week 2011      
• Pepsi During Fashion Week 2011   
• Oxygen Network Pilots OxygenLive    
• Walgreens' SoLoMo Foursquare Program