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If the different forms of market organization were categorized in such a way that they were arranged on a line, perfect competition and monopoly would occupy the two end points of the line. They are, in many senses, polar opposites. Monopoly has no competition, with only one seller, while perfect competition has many sellers competing. Monopoly goods have, essentially, no substitutes, while competitive goods have many perfect substitutes. Monopolistic markets do not produce goods at minimum costs and can make profits in the long run, while competitive markets produce goods at minimum costs and make no long-run profit. The one thing that these two markets do have in common is that they are both extreme examples of markets that are rarely seen in real-world business. In reality, most firms that operate in the U.S. have qualities of both of these markets. REALITY CHECK: Take, for example, a local pizza shop. It is like a perfectly competitive firm, because there are a lot of other places that sell pizza, and it is not hard to get into (or out of) the market. It is also like a monopoly because each pizza place makes a unique pizza and some pizzas are of a better quality than others. Therefore, most businesses are an odd mix of monopoly and perfect competition. The reason that monopoly and perfect competition are studied in such detail is to understand how the unique qualities of each of these types of market organizations come together to determine the behavior of most U.S. firms. Two types of market organizations will be studied in this chapter: monopolistic competition and oligopoly. Monopolistic CompetitionMonopolistic competition is a mixture of monopoly and perfect competition. A monopolistically competitive industry has the following characteristics:
The key to understanding monopolistic competition is the role of the unique product. Monopolistic competition is very much like perfect competition in the large number of firms and the absence of barriers to entry. But the perfectly competitive firm has a flat demand curve because it produces the same product as other firms; thus, any change in price will cause households to buy from another firm. The monopolistically competitive firm, on the other hand, produces something that is unique but similar to other firms’ goods¾just like a pizza shop produces a unique pizza that is similar to pizzas available elsewhere. The uniqueness of the good means that the demand curve for the monopolistically competitive firm is downward sloping. (Remember that, as there are more substitutes, the demand curve gets flatter (more elastic). The fewer substitutes for the monopolistic competitor’s good, the steeper (less elastic) the demand.)
REALITY CHECK: Remember, we are really talking about market power, the power to raise the price without losing customers. A firm can have power because of its size or because it has convinced consumers that its product is different from (and better than) those of its rivals. Do you frequent one particular pizza shop or haircutting salon? Why?
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