Market Structures: Competition, Monopoly, and Oligopoly
Competition
Rivalry among several companies trying to sell the same kind of goods or services to the plaintiffs in that market.
Perfect Competition
Characteristics
In this market, there are very few barriers to entry and exit. There are a lot of small producers who make an insignificant portion of the total market. The good exchanged is homogeneous; i.e., there is no difference between the products. Producers and consumers are familiar with the product characteristics and price. The producer has no power to set prices. There are many suppliers and demanders, and no company can influence the market price. This leaves the consumer to benefit most.
Long-Term Equilibrium
Producers try to achieve cost reductions to gain that level of prices. The equilibrium price is where producers cover their costs.
Short-Term Equilibrium
The combination of supply and demand leads to an equilibrium price and quantity; market conditions in the short term influence the behavior of all producers and all applicants for a product.
Monopolistic Competition
A market characterized by having a large number of bidders, but with one big difference from perfectly competitive markets: firms produce goods that differ. The characteristics of monopolistic competition markets are:
- There are few barriers to entry and exit.
- There are a lot of producers.
- The good that is exchanged is a differentiated product.
- The producer has some power to set the price.
Oligopoly
In this market, the number of bidders is small compared to the number of customers. An oligopoly occurs in sectors where entry barriers to economic activity are high. These high barriers create oligopolies with the following characteristics:
- The number of companies competing in the market is small.
- They are usually large companies, and each has a significant market share percentage.
- The small number of suppliers makes the decisions taken by one decisively influence what others do.
- There’s a leader that has a significantly higher percentage of market share. Normally, the leading brand sets prices and strategies, and all others react to what it does.
There is a kind of oligopoly in which bidders agree to set a single price, market share, or limit the production of the good. These behaviors are called collusive oligopoly or cartel, which is a formal agreement that multiple firms operating in an oligopolistic market make to achieve higher profits through joint price fixing, market sharing, or limitation of global production. These behaviors are prohibited by competition laws.
Game Theory
A theory that studies the behavior of economic agents in situations of interdependence. A dominant strategy is adopted by a company independently, without considering other competitors.
The Behavior of Competitors
Three possible behaviors of competitors:
- Cooperative: bidders agree on production, and everyone wins.
- Non-cooperative or Nash equilibrium: when cooperation is not possible for whatever reason, each company chooses to pursue the dominant strategy, which will lead to the worst-case scenario (less benefit for all).
- Unfair: when, after having reached a prior agreement, one or more companies decide not to comply for additional benefits. If one company starts with this behavior, all adopt the same strategy.
Ways to Overcome the Non-Cooperative Equilibrium
Two companies in an oligopolistic market expect to compete with each other for a longer possible time. This may encourage companies to pursue prudent behavior that produces tacit collusion, which is given in an oligopoly situation where, without a formal agreement, the competitors decide not to lower prices or limit production to avoid reducing their benefits.
The Monopoly
In this market, there is a single bidder or multiple, but one of them has over 90% market share. This is the worst kind of market for consumers, as product prices are higher.
Why Monopolies Exist?
A monopoly is a market where one company controls all or most of the supply of a product. For a monopoly to exist, there have to be big barriers to prevent any company from producing the good. This can occur in various circumstances:
- When a company controls all the resources necessary to produce that good.
- When a company holds sufficient technological control to provide a unique product. The fact that most people use their products generates new customers entering the market who prefer to use the programs that everybody has.
- When a state only allows one company to offer a certain product. This is called a legal monopoly. Currently, legal monopolies arise from patents that prevent any company from copying and producing what one has patented.
- Rural monopolies exist in the public supplies of water, electricity, cable, telecommunications, natural gas, etc. It is cheaper to have a single company; they are activities with high fixed costs but very low variable costs. The decreasing average or unit costs cause these natural monopolies.
The Consequences of Monopoly
A monopoly seeks to make the maximum profit possible, allowing it to set prices. This does not mean it can set the price it wants without restrictions, as the market demand limits it. Therefore, in a monopoly situation, the price is always higher than when there is competition (even imperfect), and the amount produced is always less.