Compare and contrast the characteristics of monopolistically competitive, monopolistic, and perfectly competitive markets.
Provide an organization that is an example of each and discuss how changes in their pricing affect your purchase decisions.
Sample Solution
Monopolistic Competition
- Many sellers: There are many sellers in a monopolistically competitive market, but each seller produces a slightly differentiated product. This means that there is some competition between sellers, but each seller has some degree of market power.
- Free entry and exit: There is free entry and exit in a monopolistically competitive market. This means that new sellers can enter the market easily, and existing sellers can exit the market easily.
- Non-price competition: Sellers in a monopolistically competitive market compete on factors other than price, such as product quality, advertising, and service.
- Some control over price: Sellers in a monopolistically competitive market have some control over price. They can raise prices above the marginal cost of production, but they cannot raise prices too high or else they will lose customers to other sellers.
- Excess capacity: Monopolistically competitive markets often have excess capacity. This means that there is unused production capacity in the market.
Examples:
- Retail stores: There are many retail stores in a market, but each store sells slightly different products. For example, there are many clothing stores, but each store sells different brands and styles of clothing.
- Restaurants: There are many restaurants in a market, but each restaurant serves slightly different food. For example, there are many Italian restaurants, but each restaurant serves different types of Italian food.
How changes in pricing affect purchase decisions:
If the price of a product in a monopolistically competitive market increases, consumers may switch to a similar product from a different seller. This is because there are many sellers in a monopolistically competitive market, and each seller produces a slightly differentiated product.
Monopoly
- One seller: There is one seller in a monopoly market. This means that the seller has complete control over the market.
- No free entry or exit: There is no free entry or exit in a monopoly market. This means that new sellers cannot enter the market, and existing sellers cannot exit the market easily.
- Price setting: The seller in a monopoly market has complete control over price. The seller can set the price as high as they want, and consumers have no choice but to pay the price.
- Excess profits: Monopolies often make excess profits. This is because the seller has complete control over the market and can charge a high price.
Examples:
- Utility companies: Utility companies are often monopolies. This is because it is not practical to have multiple utility companies serving the same area.
- Intellectual property: Intellectual property, such as patents and copyrights, can create monopolies. This is because the owner of the intellectual property has the exclusive right to produce and sell the product.
How changes in pricing affect purchase decisions:
If the price of a product in a monopoly market increases, consumers have no choice but to pay the price. This is because there is no other seller of the product.
Perfect Competition
- Many sellers: There are many sellers in a perfectly competitive market. This means that each seller has a very small share of the market.
- Identical products: The products sold by the different sellers in a perfectly competitive market are identical. This means that consumers do not care which seller they buy from.
- Free entry and exit: There is free entry and exit in a perfectly competitive market. This means that new sellers can enter the market easily, and existing sellers can exit the market easily.
- Price takers: Sellers in a perfectly competitive market are price takers. This means that they cannot set the price of their product. They have to accept the market price.
- Zero profits: In the long run, perfectly competitive markets make zero profits. This is because the entry of new sellers drives down prices until the point where profits are zero.
Examples:
- Agriculture: Agricultural markets are often perfectly competitive. This is because there are many farmers who produce identical products.
- Stock markets: Stock markets are also perfectly competitive. This is because there are many buyers and sellers of stocks, and the products (stocks) are identical.
How changes in pricing affect purchase decisions:
If the price of a product in a perfectly competitive market increases, consumers will switch to a similar product from another seller. This is because the products sold by the different sellers in a perfectly competitive market are identical.