Compare Perfect Competition Monopoly Monopolistic Competition and Oligopoly Term Paper

Excerpt from Term Paper :

Perfect Competition, Monopoly, Monopolistic Competition and Oligopoly

The subject of competition is an interesting one. The general idea in economics seems to be, the more competition the better. "Good competition" results in a greater likelihood in overall efficiency and low prices.

There are several main types of competition, these include, perfect competition, the most competitive market possible (and, presumably, the one of greatest value to the consumer), monopoly, the least competitive market (and the one of greatest value to the monopolistic producer), monopolistic competition, a market characterized by the presence of some amount of competition between a relatively small group of companies/producers, and, finally, oligopoly, the market condition when a few companies form, through a kind of collusion, a kind of pseudo-monopoly.

The first type of competition is perfect competition. Although touted and wished for by many as the perfect economic system, its existence, much like the existence of "a perfect world," is extremely unlikely.

One of the major difficulties inherent in "perfect competition" is the problem of "sameness." In order for a market to be characterized as having perfect competition, it must involve products that are always extremely similar to each other (in fact, almost identical). For instance...take phone straps...If a market were going to be perfect in its competition over phone straps, it would either be necessary for all the phone straps to be identical, or for all companies to offer a similar (or identical) range of phone strap options. If they didn't, and, say, one company began making "hello-kitty" phone straps while the other companies made plain phone straps, and the consumer started preferring hello-kitty products...well, then, the hello-kitty phone strap company would have an advantage (and all other plain strap companies would begin producing hello-kitty as well, making them all, again, identical). Obviously, this is not exactly good for innovation or variety. Good for prices, yes...variety, no.

This is one reason that perfect competition is almost always thought of in terms of agricultural products and other "primary commodities," i.e. "they are what they are" products. (Although other market factors, like government subsidies, for example can throw perfect competition off in this area as well.)

Be that as it may, perfect competition, as a system, is characterized by several assumptions, including:

Each company/producer produces exactly the amount of output that the market demands (it is impossible for a company to drive up price by restricting output, because other companies will simply take their share.).

Buyers have no influence over price (as individuals).

The market price is not under the control of either buyer or seller, and both are aware of this fact (suggesting that an ideological component is necessary).

There is total freedom of entry and exit.

Companies must produce products that are identical and perfect substitutes (hello-kitty).

Consumers must have "perfect knowledge" about the prices and products produced.

There are no outside forces (externalities) acting on the market. (Either positive or negative, i.e. subsidies or environmental liabilities, etc.)

The problem with the model of competition is its focus on homogeny. This makes it extremely impractical (and, to many, not particularly desirable). Further, there is evidence that due to the existence of markets that are very competitive, and function more efficiently (in the dynamic sense) than the "perfect" model, it may not be so perfect after all.

On the other end of the competition spectrum, lies monopoly. In a market where there exists a monopoly, a product (or even a service) that has no substitute is provided by a single company.

In this case, the company that produces the novel product or service, for example, golden egg-laying chickens, has the power (market power) to set the price on that product. They do this by controlling production of the magic chickens. After all, if there are only ten magic chickens per store, the consumer will pay more to get their hands on one than if there were an unlimited supply.

Like perfect competition, actual, complete monopolies are very rare. The possibility of a single company having complete control over a particular producible product is not only uncommon, but is usually short-lived (simply because sooner or later, other producers figure out how to produce the same or similar product, the patent runs out, etc.)

Another factor that makes real monopolies rare is the existence of outside limiting forces, like government regulations. These include antitrust policy and involuntary price regulation.

Another form of competition in the market is known as monopolistic competition.

Monopolistic competition, or imperfect competition as it is sometimes called, is in the middle between the two extremes of perfect competition and monopoly. It is the model of competition that is most common in the "real world."

In monopolistic competition, there is variation and innovation in products, and the communication of these differences (most often, through advertising), alerts the consumer to these differences. Here, it is possible for a company to earn extra profits (unlike in perfect competition), and it is also possible to have some measure of competition. (Here the consumer loses in price compared to a perfect competition system, but gains in dynamic efficiency).

The fourth competition model is known as an oligopoly.

An oligopoly exists when the market is dominated small group of companies/producers, and they almost dominate the market for a particular product or service. They almost always use advertising to communicate the advantages of their products to the consumer, and their huge share of the market creates extremely large hurdles for a smaller or new company seeking to enter that particular market.

Although, oligopoly seems similar to monopolistic competition, the key difference is the complete interdependence between companies/producers -- i.e. almost like a perfect competition among those companies only.

This interdependence among these companies means that each one must consider the reaction of the other companies (in the club) when making decisions in setting price, modifying/creating products, and in making investment decisions. This creates a problem in the ability to analyze the behavior of such markets -- a problem that is managed with something called game theory.

In game theory, companies must consider the likely "moves" or reasoning of those in the "other company" (or companies), much like a game player considers/weighs/and tries to predict the next move of his or her opponent. Although game theory is highly developed (and can even be used in other applications), oligopoly is still difficult to predict in some ways, because of interdependent product decisions and pricing.

One cannot discuss the subject of competition in markets without considering the impact of government regulation. After all, markets do not exist in a vacuum, but in a complex world of subsidies, tariffs, taxes, embargos, laws and regulations.

The reason regulation exists is precisely because markets do operate in the real, often messy and complicated, world -- one that includes political, environmental, cultural, social, and economic (in regard to chance resource allocation, for example) factors. These factors are known as externalities.

Regulation is most often applied in relation to environmental issues (for example the commercial market might not regulate itself with regard to pollution), to allowable rates of return (the idea that certain companies/industries must not exceed a certain percentage above a specific rate chosen by the government (often used in utilities, for example)).

However, although regulation is considered (again, like perfect competition), to be "good," it can also result in inefficiency. For example, in the case of rate of return regulation, the company forbidden to make more than a certain rate of return might be tempted to keep down it profit on purpose in order to keep this rate down. That is highly inefficient. Subsidies may lead to over-production of a product, waste, and may cause global economic destabilization (which can lead to political destabilization) by flooding the global market with unnaturally cheap products (destabilizing markets elsewhere).…

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