Economics Online Tutor
We know that all firms will maximize profits at the output level where mr=mc.
In the real world, firms operate in a large variety of environments. These
different environments, based on different market conditions, influence the
behavior of different firms in different ways.
In order to analyze this real life behavior, economists have identified
characteristics that make some firms similar to each other, and other firms
different from one another. This has led to the study of firms based on four
categories of market structure: perfect competition, monopolistic
competition, oligopoly, and monopoly.
The characteristics of each market structure relate to differences in the
demand curves faced by firms in each category.
The identifying characteristics for each type of market structure include the
number of firms in the industry, whether the products are identical
(homogeneous), ease of entry for new firms in the industry, and the power
that the firm has to influence the price of its products.
The following table summarizes the characteristics of the four types of
Perfect competition and monopoly are extremes at the opposite ends of the competitive spectrum.
Most real world firms have characteristics that more closely resemble the monopolistic competition
and oligopoly models.
For each of these four models of market structure, i have included a section which explains some of
the details that distinguish one market structure from the rest. You can jump to each of these sections
by clicking on the corresponding link.
Besides the above table, which identifies the characteristics of each market structure, the following
summary of conclusions from the details of each section should be helpful:
Perfect competition is the market structure that maximizes efficiency, as determined by total
surplus. Perfect competition gives consumers more total output at a lower price than other
market structures. Firms produce where P=MR=MC, which is at minimum average cost.
Advertising is non-existent, since products are identical in the minds of consumers. The only
competition is price competition, yet each firm is a price taker. Ease of entry and exit means
that all firms will earn normal, not economic, profits in the long run.
Monopolistic competition: differentiated products allow for more consumer choices than
perfect competition. Higher prices and lower total output result in less efficiency than perfect
competition. Firms do not produce at minimum average total cost. However, this lower
efficiency results from consumer preference for more choices, not from economic profits. In
the long run, economic profits do not exist. Advertising is an important part of product
Oligopoly: more than one model is needed to explain the behavior of firms in an oligopoly
market structure. Non-price competition can be fiercer than any other market structure; on the
other hand, anti-competitive cooperation may exist. Advertising is an important part of
competition. So is research and development. Oligopoly is the market structure most
responsible for technological advances. Price is above mc, and long run economic profits are
possible as long as entry is restricted.
Monopoly: with only one firm in the market, consumers are not given a choice of products. A
monopolist has market power, and will set its output at the quantity where MR=MC, which is a
lower quantity than the quantity under perfect competition, where MR=demand. At the same
time, a monopolist will set its price where the MR=MC quantity equals demand, which is a
higher price than perfect competition, where P=MC. With monopoly, advertising and innovation
are unnecessary. Long run economic profits are possible.
A discussion of each market structure can be accessed by clicking on its name in the summary
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