Market Structures within a Free Market
One of the characteristics of a free market system is that suppliers have the right to compete with one another. The number of suppliers in a market defines the market structure. Here, the term market does not refer to all the activities within the economy. Rather, we are looking at businesses that are in competition with each other.
types of market structures
- perfect competition
- pure monopoly
- monopolistic competition
- oligopoly
Perfect Competition
Characteristics of perfect (pure) competition include:
- A large number of small firms are in the market.
- The firms sell similar products; that is, each firm’s product is very much like the products sold by other firms in the market.
- Buyers and sellers in the market have good information about prices, sources of supply, and so on.
- It is easy to open a new business or close an existing one.
In a perfectly competitive market, many firms sell their products at prices determined solely by forces beyond their control. Because the products are very similar and each business contributes only a small amount to the total quantity available for sale, price is determined by supply and demand. A business that raised its price even a little above the going rate would lose customers. In the wheat market, for example, the product is essentially the same from one wheat producer to the next. Thus, none of the producers has control over the price of wheat.
Pure Monopoly
At the other end of the spectrum is pure monopoly, the market structure in which a single business accounts for all industry sales of a particular good or service. The firm is the industry. This market structure is characterized by barriers to entry, the factors that prevent new firms from competing equally with the existing firm. Often the barriers are technological or legal conditions. Polaroid, for example, held major patents on instant photography for years. When Kodak tried to market its own instant camera, Polaroid sued, claiming patent violations. Polaroid collected millions of dollars from Kodak. Another barrier may be one firm’s control of a natural resource. DeBeers Consolidated Mines Ltd., for example, controls most of the world’s supply of uncut diamonds.
Public utilities, such as gas and water companies, are pure monopolies. Some monopolies are created by a government order that outlaws competition. In Alabama, Idaho, New Hampshire, North Carolina, Pennsylvania, Utah and Virginia, liquor stores are owned by the state government; no private ownership is permitted.[1]
Monopolistic Competition
Three characteristics define the market structure known as monopolistic competition:
- Many firms are in the market.
- The firms offer products that are close substitutes but still differ from one another.
- It is relatively easy to enter the market.
Under monopolistic competition, firms take advantage of product differentiation. Industries where monopolistic competition occurs include clothing, food, and similar consumer products. Firms under monopolistic competition have more control over pricing than do firms under perfect competition because consumers do not view the products as perfect substitutes. Nevertheless, firms must demonstrate product differences to justify their prices to customers. Such distinctions may be significant or superficial. For example, Chipotle emphasized the quality of their ingredients and positioned themselves as a healthy fast food alternative.[2]
Oligopoly
An oligopoly has two characteristics:
- A few firms produce most or all of the output.
- Large capital requirements or other factors limit the number of firms.
Boeing and Airbus Industries (aircraft manufacturers) and Apple and Google (operating systems for smartphones) are major players in different oligopolistic industries.
With so few firms in an oligopoly, what one firm does has an impact on the other firms. Thus, the firms in an oligopoly watch one another closely for new technologies, product changes and innovations, promotional campaigns, pricing, production, and other developments. For example, facing increasing competition from Airbus’ fuel-efficient A320 airplane, Boeing rushed to bring the 737 Max to market much faster than they had ever previously introduced a new design. When two Boeing 737 Max airplanes crashed within the space of 5 months in 2019, many blamed the tragedies on Boeing putting profit before safety.[3]
Anticompetitive Behavior
Sometimes businesses go so far as to coordinate their pricing and output decisions but that is illegal in the United States. This kind of coordination can be anticompetitive, meaning that it interferes with the usual ability of supply and demand in the market to set prices that are fair to consumers. Many antitrust cases—legal challenges based on laws designed to limit anticompetitive behavior—occur in oligopolies.
The market structure of an industry can change over time. Take, for example, telecommunications. At one time, AT&T had a monopoly on long-distance telephone service nationwide. Then the U.S. government divided the company into seven regional phone companies in 1984, opening the door to greater competition. Other companies such as MCI and Sprint entered the fray and built state-of-the-art fiber-optic networks to win customers from the traditional providers of phone service. Today, the broadcasting, computer, telephone, mobile communications, and video industries are converging as companies consolidate through merger and acquisition.