Market Structures: Competition, Monopoly, and Oligopoly Explained

Posted on Jan 26, 2025 in Economy

Market Structures: Competition, Monopoly, and Oligopoly

Perfect Competition

In a perfectly competitive market, a large number and dispersion of buyers and sellers prevent any of them from having a major influence on price.

  • Many small merchants exist, so none will have any significant influence on the price of a certain good or service.
  • The product is homogeneous throughout the market; therefore, it is indifferent for consumers to buy from one dealer or another.
  • Buyers are well-informed about prices and quantities offered.
  • There is free entry and exit for companies. It’s easy to enter as a supplier because the initial investment is not high.
  • In the long term, if there are profits, new producers will enter, and the price will go down until the profits are gone.
  • The price is determined by the market, without outside interference.

Example of a Perfectly Competitive Market: Agricultural Markets

Special features:

  1. Producers have a small volume and, therefore, very limited influence.
  2. The goods are perishable and require refrigeration/preservation.
  3. It depends largely on the weather.
  4. Producers depend very directly on the selling price (and have little leeway).
  5. Producers depend on very expensive or difficult resources such as land, water, seeds, etc.
  6. Greater rigidity (short term) of the offer.

Policies that apply:

  1. Minimum prices
  2. Subsidies

Sometimes production is cut or limited because there is a large surplus.

Imperfect Competition

Imperfect competition exists when there is market power by one or some of the participating companies.

Monopoly

A monopoly is a market in which there is only one seller offering the product to many buyers. It establishes a higher price and offers a much smaller quantity than in a perfectly competitive market.

A market is considered a monopoly when:

  • There’s only one company offering the product.
  • The product is not homogeneous, and there are no other substitutions.
  • There are barriers to entry into the market.

Types of Monopoly

  • Legal: Has legal protection by the state.
  • By secrecy: The company is the only one that knows a specific formula. (e.g., Coca-Cola)
  • Natural: A company can produce all the market’s production with a lower cost than if there were several competing companies. (e.g., drinking water distribution in cities)

Oligopoly

An oligopoly is a market structure where a few vendors participate, with strong interdependence.

Features:

  • A few suppliers share almost all the demand.
  • Barriers to entry for new competitors.
  • Interdependence of behaviors and decisions.
Business Mergers
  • Vertical merger: Involves companies controlling various stages of the production process of the same product. (e.g., Repsol-YPF)
  • Horizontal merger: Formed by companies that develop the same products. (e.g., merger of banks BBVA)
  • Conglomerate merger: Groups independent companies within an organization.
The Cartel

The cartel is the utmost form of cooperation, which maximizes the benefits of oligopolists. It is an agreement among all producers concerned that can take two forms:

  • Competition regardless of price.
  • Distribution of quotas or market.

Monopolistic Competition

Monopolistic competition refers to markets that have characteristics of both perfect competition and monopoly. Each company has a monopoly on the sale of a product, but the various brands compete with substitute products.

Features:

  • Many bidders, each holding a small share of the market.
  • There are no barriers to entry for new companies.
  • There is a difference between product or brand, so prices may vary. Each company has a monopoly on its product.

Market Failure

Market failure occurs when the market does not lead to economic efficiency.

Causes of Market Failures

  • External effects or externalities (effects of certain economic activities that affect other agents positively or negatively without them paying or being compensated for this fact).
  • The provision of public goods.
  • Complex failures.

Positive and Negative Externalities

Differences:

  • Positive externalities represent a positive benefit to a third party without causing any cost in return. Negative externalities represent a loss for the third party.
  • Positive: Improving a road for a company benefits the communications of a nearby village for free.
  • Negative: Pollution due to river discharges from a chemical company. The social cost involved in the existence of negative externalities forces the state to intervene as a compensatory mechanism.