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Monopolistic Market vs. Perfect Competition: An Overview
A monopolistic market and a perfectly competitive market represent two market structures that have several key distinctions in terms of market share, price control, and barriers to entry. In a monopolistic market, there is only one firm that dictates the price and supply levels of goods and services, and that firm has total market control. A perfectly competitive market is composed of many firms, where no one firm has market control.
Monopolistic and perfectly competitive markets affect supply, demand, and prices in different ways. In the real world, no market is purely monopolistic or perfectly competitive. Every real-world market combines elements of both of these market types.
Key Takeaways:
- In a monopolistic market, there is only one firm that dictates the price and supply levels of goods and services.
- A perfectly competitive market is composed of many firms, where no one firm has market control.
- In the real world, no market is purely monopolistic or perfectly competitive.
- In between a monopolistic market and perfect competition lies monopolistic competition or imperfect competition.
- In monopolistic competition, there are many producers and consumers in the marketplace, and all firms only have a degree of market control.
Monopolistic Markets
In a monopolistic market, firms are price makers because they control the prices of goods and services. In this type of market, prices are generally high for goods and services because firms have total control of the market. Firms have total market share, which creates difficult entry and exit points. Since barriers to entry in a monopolistic market are high, firms that manage to enter the market are still often dominated by one bigger firm.
A monopolistic market generally involves a single seller and buyers do not have a choice concerning where to purchase their goods or services.
Purely monopolistic markets are extremely rare, and perhaps even impossible, in the absence of absolute barriers to entry, such as a ban on competition or sole possession of all natural resources. Sometimes, however, a government will establish a monopolistic market to ensure national interests or maintain critical infrastructure. For instance, many utilities such as power companies or water authorities may be granted a monopoly status for a certain area.
In the absence of such permission, governments often have laws and enforcement mechanisms to promote competition by preventing or breaking up monopolies. This is because a monopolistic market can often become inefficient, charge customers higher prices than would otherwise be available, and can prevent newcomers from entering the market. Thus, there are various antitrust regulations that keep monopolies at bay.
A monopoly is when there is only one seller in the market. A monopsony, on the other hand, is when there is only one buyer in a market.
Perfect Competition
In a market that experiences perfect competition, prices are dictated by supply and demand. Firms in a perfectly competitive market are all price takers because no one firm has enough market control. Unlike a monopolistic market, firms in a perfectly competitive market have a small market share. Barriers to entry are relatively low and firms can enter and exit the market easily. Contrary to a monopolistic market, a perfectly competitive market has many buyers and sellers, and consumers can choose where they buy their goods and services.
Companies earn just enough profit to stay in business and no more. If they were to earn excess profits, other companies would enter the market and drive profits down. As mentioned earlier, perfect competition is a theoretical construct. As such, it is difficult to find real-life examples of perfect competition.
Pricing in perfect competition is based on supply and demand while pricing in monopolistic competition is set by the seller.
Special Considerations
According to economic theory, when there is perfect competition, the prices of goods will approach their marginal cost of production, or the cost of producing one additional unit. This is because any firm that tries to sell at a higher price in an attempt to earn excess profits will be undercut by a competitor seeking to grab market share. This also promotes a sort of technological arms race in order to reduce the costs of production so that competitors can undercut one another and still earn a profit. Over time, however, as technology diffuses through to all producers, the effect is to lower consumer prices even further, as well as to erode profits for producers.
In between a monopolistic market and perfectly competitive market lies monopolistic competition. In monopolistic competition, there are many producers and consumers in the marketplace, and all firms only have a degree of market control. In contrast, whereas a monopolist in a monopolistic market has total control of the market, monopolistic competition offers very few barriers to entry. All firms are able to enter into a market if they feel the profits are attractive enough. This makes monopolistic competition similar to perfect competition.
However, in a monopolist competitive market, there is product differentiation. Products in monopolistic competition are close substitutes though the products have distinct features, such as branding or quality. This is unlike both a monopolistic market, where there are no substitutes for products, and perfect competition, where the products are identical.
In reality, all markets will display some form of imperfect competition. That is because there will always be some barriers to entry, some information asymmetries, larger and smaller competitors, and small differences in product differentiation.
What Are the Differences Between Monopolistic Markets and Perfect Competition?
In a monopolistic market, there is only one seller or producer of a good. Because there is no competition, this seller can charge any price they want subject to buyers’ demand and establish barriers to entry to keep new companies out. On the other hand, perfectly competitive markets have several firms each competing with one another to sell their goods to buyers. In this case, prices are kept low through competition, and barriers to entry are low.
What Is the Difference Between a Monopoly and a Monopolistic Market?
A monopoly refers to a single producer or seller of a good or service. A monopolistic market is the scope of that monopoly. For instance, XYZ Co. may be a monopoly producer of widgets. It can control a monopolistic market over all the widgets sold in the United States whereby nobody else sells widgets.
What Are the Main Characteristics of Perfect Competition?
In a perfectly competitive market, all firms sell an identical product; all firms are price-takers; all firms have a relatively small market share; buyers know the nature of the product being sold and the prices charged by each firm; and the industry is characterized by freedom of entry and exit. In reality, some or all of these features are not present or are influenced in some way, leading to imperfect competition.
The Bottom Line
Monopolistic markets and perfectly competitive markets are two different types of market structures. Monopolistic markets are characterized by the domination of one firm, which can dictate price, supply, barriers to entry, and other terms. In contrast, perfectly competitive markets are composed of many firms, where no single firm has total control.
In the real world, most markets are neither monopolistic nor perfectly competitive. Rather, they exist on the spectrum between these two types.