The Four Industry Types
An industry can be classified in one of four market types:
1. Pure competition.
Pure competition is a market structure in which there are many competing firms selling identical products or services. Very few, if any, industries in the real world are purely competitive, because it is believed that each company is unique and has at least a very small amount of monopoly power. Economists still find it useful to analyze this market structure, because it allows us to better understand the other three more-realistic market structures. We learn about pure competition in this unit. The farming industry is one of the closest examples of pure competition in the United States, and is highlighted in Section 7.
A monopoly is an industry with only one seller. The product that the firm sells has no close substitutes. Monopolies can be firms that are granted exclusive production rights by a government. They can also be firms that have attained monopoly powers through efficient free market production methods and economies of scale. We analyze monopolies in Unit 7.
3. Monopolistic competition.
Monopolistic competition is a market structure in which there are many small firms selling slightly differentiated products or services. Monopolistic competition is different from monopoly. The emphasis in monopolistic competition is on “competition.” In a monopoly industry, there exists no or very little competition. In a monopolistically competitive industry, there are many competing firms. We study monopolistic competition in Unit 8.
In an oligopoly industry, a small number of firms is responsible for the majority of the sales. Because firms in this industry are usually big, actions of one firm (for example, a price cut or an aggressive advertising campaign) significantly affect actions of rival firms. Sometimes oligopoly firms collude (work together) in order to make larger profits. We look at oligopolies in Unit 8.
The Four Characteristics of Pure Competition
Pure competition, the market structure discussed in this unit, has the following characteristics:
1. Many sellers.
There are many sellers and many buyers. Companies are small, and hundreds of companies compete.
2. Easy entrance.
It does not require much know-how and capital to start a purely competitive business.
3. Identical products.
One firm’s product is identical to a competitor’s product (homogeneity). Gasoline sold by gas station A is identical to gasoline sold by gas station B.
4. Perfect information.
Buyers have complete knowledge of the price, the quality, and the nature of the product. The more knowledge buyers have of the competitors’ prices and product qualities, the more competitive the market is. The opposite is true as well. If there are 100 or more firms in the industry, but if buyers are only aware of one firm, then this one firm can act like a monopoly and charge high prices.
Because of the extreme nature of characteristics 3 and 4, no industry is purely competitive. The farming industry, the stock market industry, and the retail gas station industry are very competitive, but they are technically monopolistically competitive (see Unit 8). However, they come close to resembling purely competitive markets.
In the following sections, we will discuss revenue curves of purely competitive firms. We will then compare these revenue curves to cost curves of firms, as discussed in the previous unit. A firm’s total revenue minus its total costs equals its total profit. Therefore, we will be able to derive the purely competitive firm’s profit, and calculate at which output the firm maximizes profits.