Economists assume that there are a number of different buyers and
sellers in the marketplace. This means that we have competition in the market, which allows price to change in response to changes in supply and demand.
Furthermore, for almost every product there are substitutes, so if one
product becomes too expensive, a buyer can choose a cheaper substitute
instead. In a market with many buyers and sellers, both the consumer and
the supplier have equal ability to influence price.
In some industries, there are no substitutes and there is no
competition. In a market that has only one or few suppliers of a good or
service, the producer(s) can control price, meaning that a consumer
does not have choice, cannot maximize his or her total utility and has
have very little influence over the price of goods.
A monopoly is a market structure in which there is only one producer/seller for a product. In other words, the single business is
the industry. Entry into such a market is restricted due to high costs
or other impediments, which may be economic, social or political. For
instance, a government can create a monopoly over an industry that it
wants to control, such as electricity. Another reason for the barriers
against entry into a monopolistic industry is that oftentimes, one
entity has the exclusive rights to a natural resource. For example, in
Saudi Arabia the government has sole control over the oil industry. A
monopoly may also form when a company has a copyright or patent that
prevents others from entering the market. Pfizer, for instance, had a
patent on Viagra.
In an oligopoly,
there are only a few firms that make up an industry. This select group
of firms has control over the price and, like a monopoly, an oligopoly
has high barriers to entry. The products that the oligopolistic firms
produce are often nearly identical and, therefore, the companies, which
are competing for market share, are interdependent as a result of market
forces. Assume, for example, that an economy needs only 100 widgets.
Company X produces 50 widgets and its competitor, Company Y, produces
the other 50. The prices of the two brands will be interdependent and,
therefore, similar. So, if Company X starts selling the widgets at a
lower price, it will get a greater market share, thereby forcing Company
Y to lower its prices as well.
There are two extreme forms of market structure: monopoly and, its opposite, perfect competition.
Perfect competition is characterized by many buyers and sellers, many
products that are similar in nature and, as a result, many substitutes.
Perfect competition means there are few, if any, barriers to entry for
new companies, and prices are determined by supply and demand. Thus,
producers in a perfectly competitive market are subject to the prices
determined by the market and do not have any leverage.
For example, in a perfectly competitive market, should a single firm
decide to increase its selling price of a good, the consumers can just
turn to the nearest competitor for a better price, causing any firm that
increases its prices to lose market share and profits.
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