Market structures: from competition to monopoly

A wheat farmer can’t pick her price: ask more than the going rate, and buyers go to the next farm. A café can charge a little more for coffee its regulars love. Your phone runs on one of a few networks, each watching the others’ prices. Your tap water probably comes from just one supplier. These four markets answer one question differently: who sets the price?

The answers give four market structures (ways a market can be organised), from most competition to least:

(Normal profit: just enough to stay in business. Economic profit is anything above it.)

That flat line is what “price taker” means: the firm chooses how much to sell, never the price. In the other structures, each firm’s demand curve slopes down: a firm can raise its price and lose only some customers.

Cafés are one step further from perfect competition. A town might have 30, and opening another is cheap. But each café’s coffee, location and feel differ, and branding (a name and style people trust) makes those differences stick. That’s monopolistic competition: many firms, each with a tiny monopoly over its own brand.

Firms with rivals often win customers in one of two ways. Differentiation is being different or better, so buyers pay more. Cost leadership is having the lowest costs, so the firm can charge the lowest prices. Budget airlines win this way.

A second set of water pipes under every street would cost a fortune, so one supplier serves the whole town. That’s a monopoly, at the far end of the scale: one seller, no close substitute and very high barriers. With nowhere else for buyers to go, a monopoly tends to charge more and sell less than a competitive market would.

Market power isn’t always bad. A new medicine costs a fortune to invent but little to copy. A patent stops rivals copying it for some years, and the profit from those years pays for the research.

Without rivals, though, a monopoly can charge too much and grow lazy. That’s why many countries have a competition authority. This public body can block mergers (two firms becoming one) and act against price-fixing (rivals agreeing on prices).

Between monopolistic competition and monopoly sits oligopoly: a few big firms, usually kept few by high barriers to entry. Each firm’s moves hit the others, so they watch each other. Picture two petrol stations at a crossroads, each choosing a high price or a price cut. Their daily profits, in dollars:

If both keep prices high through a quiet understanding (an unspoken agreement not to undercut), each earns 1,000 dollars. But whatever B does, A earns more by cutting: 1,500 instead of 1,000, or 600 instead of 300. B feels the same pull. If both cut, a price war (rivals undercutting each other) leaves each with 600. A formal deal to keep prices high is a cartel, illegal in many countries.