In a market economy, competition is important because it provides consumers with options.
These options benefit us as consumers since we have a variety of different alternatives
and firm’s compete for our business.
This tends to drive prices down, which is also good for consumers.
Now although markets generally contain a number of firm’s battling for consumers’ wallets,
not all markets share the same degree of competition.
There are in fact four general degrees of competition that help to characteristic markets.
These classifications are important because they give us a sense for just how competitive
a market will be, which is important for new firms.
They also help to indicate just how much power firms have over setting prices or whether
that power rests in the hands of consumers.
In general, we of course want competition since it forces firms to provide solutions
to our problems in an effective and efficient manner.
So lets dive in to some of the different classifications.
The first degree of competition is what’s called perfect competition.
Perfect competition, sometimes called pure competition, describes a market that contains
a large number of firms with relatively little market power.
No firm has the ability to affect price largely because the perception is that products are
really commodities.
Meaning they are perceived to have no real difference from others in the market.
Since products are perceived as identical, firms can’t really change their prices drastically
since they would forfeit sales opportunities to other firms.
Another characteristic is that barriers to entry are rather low.
Remember that a barrier to entry is something that prevents a firm from entering a market
and competing with other firms.
These can include brand recognition, financial capital, government regulation, and others.
But because a large number of firms operate in this market, and they’re small in size,
it’s relatively easy to enter and exit a perfectly competitive market.
Truthfully, perfectly competitive markets are quite rare.
Maybe the closest example could be in the area of agriculture, but even then there are
certainly differences in agricultural products.
Further on down the line here we have monopolistic competition.
A market characterized by monopolistic competition still contains a large number of firms, however
they attempt to differentiate their products from one another.
This differentiation, whether it be based on quality, price, or service, is what allows
firms to set themselves apart from other firms and gain market share.
These types of markets are quite common, and we see them in hospitality, retail, consumer
electronics and many other areas.
Again, this attempt at differentiating one’s products results in better quality goods and
services offered at better prices for consumers.
The third degree of competition is known as an oligopoly.
An oligopoly is described as a market containing only a handful of firms that behave in a fairly
similar fashion.
Firms in this type of market are rather large as measured by assets and sales, and thus
have some control over prices in the market.
Due to the size of existing firms, barriers to entry are high, which tends to prevent
new entrants.
Probably the best examples of oligopolies in the United States include the airline and
mobile service markets.
In the cell phone market for example you have Verizon, AT&T, T-Mobile, and Sprint as the
primary players.
These firms offer similar services at somewhat similar prices.
They also tend to mimic the actions of one another since the firms are competing for
market share.
If one firm offers a new service and consumers switch, that will take market share away from
the other firms.
These types of markets tend to be heavily scrutinized by the Federal Trade Commission
and U.S. Justice Department for fear of being anti-competitive.
In fact you probably remember AT&T’s attempted merger with T-Mobile, which would’ve combined
the nations second and third wireless carriers.
The FTC and Justice Department expressed concerns that the merger would reduce our options as
consumers, which could result in higher prices.
The last degree of competition and one that really lacks competition is a monopoly.
Markets that are described as a monopoly are rather easy to understand because they only
have one firm.
From the perspective of consumers monopolies are very undesirable.
Since there’s no competition, the firm has no incentive to provide better goods or services.
In the U.S., and many other nations, the government prevents most monopolies from forming and
has established legislation to prevent the formation of monopolies.
The only instances in which monopolies are allowed to exist is when the government deems
that doing so is more efficient.
Take utilities companies that provide gas and electricity for example.
Chances are there is one retailer of gas and electricity in your area, which you could
argue is a monopoly and should be eliminated.
But the government allows these types what are called natural monopolies to exist since
more than one retailer is not needed to provide the service.
The important thing to remember here is that competition is a vital component to a market
economy.
Competition is what leads to product innovations as firms compete for market share and sales.
And it also gives consumers more power over price levels.