Understanding Market Models: Perfect and Imperfect Competition

Posted on Jul 9, 2025 in Economy

Market Models: An Introduction

To define the different market models, we analyze the concept of market structure, which refers to the number of companies existing within a market and their relative size. This structure reveals the ability of companies to influence the market price, known as the degree of market power. According to this degree, markets can be divided into the following types:

  • Perfect Competition Market: Where no single seller can influence the price.
  • Imperfectly Competitive Market: Where sellers can influence the price. This category includes:
    • Monopoly: One dominant company.
    • Oligopoly: A few dominant companies.
    • Monopolistic Competition: Many companies with differentiated products.

Perfect Competition Market

A perfect competition market is characterized by a large number of buyers and sellers, where no single vendor can influence the price. For a market to be considered perfectly competitive, it must meet four essential conditions:

  • Many Buyers and Sellers: There must be a sufficiently large number of participants on both sides of the market.
  • Homogeneous Product: The product offered is identical across all sellers; there is no difference between one seller’s product and another’s.
  • Perfect Information: Both buyers and sellers have complete and accurate understanding of market conditions and the product.
  • No Barriers to Entry and Exit: Firms can freely enter and exit the market without significant obstacles.

The implementation of these four conditions is very difficult, and in reality, very few markets exhibit perfect competition. The main examples often cited include:

  • Agricultural markets (e.g., commodity crops)
  • Farmers’ markets (for certain undifferentiated goods)
  • Stock markets (for highly liquid shares)
  • Foreign exchange markets

In a perfectly competitive market, total market supply and demand set the equilibrium price. Each individual company then decides how much to offer at that established price. Therefore, companies in this market are considered “price-takers.”

Companies can enter and exit this market freely. When opportunities for profit arise, new companies emerge and begin to produce. This dynamic ensures that, in the long term, businesses are only able to earn normal profits (zero economic profit), selling at the equilibrium price without incurring losses.

Imperfect Competition Market

Imperfect competition describes a market where sellers can influence the market price. This category encompasses several distinct market structures:

Monopoly

A monopoly is a market in which there is only one supplier that has full power to decide how much to produce and at what price. Monopolies, knowing that selling more will reduce prices, typically offer less quantity at a higher price compared to a perfectly competitive market.

Monopolies can arise for four primary reasons:

  • Exclusive Control of a Raw Material or Production Factor: A single firm owns or controls a critical input.
  • Existence of a Patent: The exclusive legal right to manufacture and sell a product for a certain period.
  • Administrative License or Concession: A government grants exclusive rights to a company to produce a good or service for a specific time.
  • Natural Monopolies: These occur in large markets where providing a service involves such high fixed costs (e.g., infrastructure and initial investments) that it only becomes profitable to produce at very large quantities, making it inefficient for multiple firms to operate.

Because monopolies often act abusively by fixing elevated prices, the state can intervene to prevent or regulate them in three ways:

  • Preventing the creation of new monopolies.
  • Splitting existing monopolies into two or three companies to foster some competition.
  • Regulating existing monopolies by setting price ceilings and applying special laws.

Oligopoly

An oligopoly is a market where there are a few sellers who exert significant control over the price, and they are mutually interdependent; that is, the performance of one company significantly affects the others. When an oligopoly exists, there are two main situations:

  • Companies Do Not Agree: In this case, there can be price wars, or one company might act as a price leader, with others following its pricing strategy.
  • Companies Agree: Companies might collude to set prices or divide the market. When oligopolies agree, they form a “CARTEL,” which is an informal grouping of associated companies designed to reduce or eliminate competition in the market.

Monopolistic Competition

Monopolistic competition is a market where there are many companies that sell products that are similar but differentiated, often through unique designs, brands, or features. These companies heavily use advertising to attract and retain customers. It is called monopolistic competition because each company, by using a unique brand, creates a small, temporary monopoly over its specific branded product, as it is the sole seller of that particular version.