Modern economies have a variety of industries.To simplify an economic analysis of all the firms or industries within an economy, first separate them based on the amount of competition they face within a particular industry.There are four primary types of market models: pure competition, monopolistic competition, oligopoly, and pure monopoly.In these last 3 categories, market competition is limited, indicating imperfect competition.
Large numbers of firms produce a standardized product in a purely competitive market.The market price is determined by consumer demand; suppliers do not have any influence over the market price, and therefore they are price takers.In general, there is a low barrier of entry to business, which explains why there are so many firms.Agricultural products such as corn, wheat, and soybeans are examples of purely competitive markets.
Monopolies tend to be more competitive than pure ones, since there are many suppliers and the barriers to entry are low.As a result, the suppliers try to achieve some price advantages by differentiating themselves from similar products.Among these are the vast majority of consumer goods, such as health and beauty aids.The products of suppliers are differentiated as being better in order to justify higher prices or to increase market share.A monopolistic competition, however, can only occur when the differentiation is significant or if the suppliers are able to convince consumers that they are significant by using marketing or advertising methods. For example, toothpaste suppliers may claim that their product can whiten teeth or prevent cavities or periodontal disease.
Markets with oligopolies are dominated by a few suppliers. .The barrier to entry is high, so the oligopolistic firms have a significant influence on the market price of their product.However, they must always consider the actions of the other firms in the market when changing prices. These firms are certain to react in a way that neutralizes any changes and allows them to maintain their market share.As an example of an oligopoly, automobile manufacturers can be considered because they have high fixed costs, thereby limiting their entry into the market.
There is pricing power within the market of a pure monopoly.One supplier has significant market power and determines the price of its product.Pure monopolies often face little competition due to high barriers to entry, such as high entry costs, or because the company has achieved significant market influence through network effects, such as Facebook.
Microsoft's production of operating systems is the best example of a pure monopoly.
The first diagram illustrates the surpluses of consumers and producers under pure competition. .The additional producer surplus occurs at the expense of the lower consumer surplus for those who buy the product.Furthermore, if the price is too high, some consumers will not buy the product, which represents Area #1.In addition, some producer surplus is lost due to fewer suppliers.This would be the producer surplus earned by the suppliers in the market if it was a competitive market, which is indicated as area #2 in the diagram. The combined areas of losses represent the deadweight loss to the economy, or the reduction of total surplus, that results from oligopolistic or monopolistic restrictions of supply.
Pure Competition Is Best for the Consumer
Consumers prefer pure competition, as it gives them the greatest surplus and maximizes the economy's total surplus.As pure competition is the easiest model to analyze from an economic perspective, we will start by studying this market model in detail.