Perfect and imperfect competition

In this video, we're going to give an overview of the types of markets that you might encounter in an economics class, and we're going to get a little bit precise with our language because you'll hear words like "perfect competition," "monopoly," or "oligopoly" a lot in economics and, frankly, even in your broader life.

Now, before we even go into those terms, I will differentiate between what's sometimes referred to as a product market and other markets that are referred to as resource markets. Now, a product market is a market where the output of that market, what the market is producing or what it's buying and selling, is something that people will consume. It doesn't just have to be a physical product; it could also be some type of a service.

So, examples of product markets could be the market for shirts, it could be cars, or it could even be a service, such as tax preparation. These would all be product markets because they're something that people would consume, and I would call this consumer tax preparation, not business tax preparation. So, this is consumer tax preparation.

Now, based on my clarification, you might guess what a resource market is all about. These are markets for the inputs into other products or into the production of other even resources. So, these would be your famous inputs or factors of production. For example, it could be the market of labor, it could be something like farmland, where farmland is used to produce something else; it could be the market for capital goods, maybe robots for factories.

But either way, whether we're talking about product markets or resource markets, we can think about them in broad terms based on how many players there are in the market and how differentiated the players are on the market, how much control they have over the price, and what the barriers to entry are.

So, let's set up a spectrum here to explore that a little bit. I will set up a spectrum now. The extreme end of the spectrum, right over here, is when you only have one player—one player in the market. Actually, let me just say one firm because "players" is not really clear; I'm not talking about whether I'm talking about a buyer or seller. One firm in the market with many buyers; you are probably familiar with what we call this market or what we would call this firm.

It has a monopoly. It has a monopoly, named for a famous game, and because that whole point of that game is to try to be that last firm standing—the firm that owns all of the real estate. Now, what are the situations that would describe a monopoly? Well, a monopoly is a situation where you have very high, one could argue, insurmountable barriers to entry—so very high barriers to entry.

Monopolies can sometimes be controversial, but they're not necessarily illegal. In fact, in many countries, a monopoly can be granted to a firm through things like intellectual property or patents. For example, a drug company, if it discovers a cure for a drug or something to maintain a drug, might be granted a monopoly for that pill for some period of time. The government does that so that they could recoup their investment in all of the R&D that they actually produced.

What often is illegal in a lot of countries is if a firm misuses its monopoly power. But anyway, now let's go to the other extreme. Let's imagine a situation where, instead of high barriers to entry, there are no barriers—no barriers to entry. Let's say that there's no differentiation and you have many players—so many, or let me write many firms.

I keep wanting to say players, but that doesn't make it that clear. So, let me say many firms and many buyers. Now, this is a state that we'll often study in our economics class; we'll call it perfect competition. In a perfect competition world, the firms essentially have to be price takers; they take whatever the market price is.

We've used that assumption in a lot of situations. In a monopoly, on the other side, they could be the price setters; they're the only player in that market. Now, in general, when anything is described as perfect, it's usually theoretical, and so is perfect competition—there are no markets that I can think of that are perfectly perfect. But I can think of ones that are close, for say, some agricultural commodities.

So, say, the sugar market. The market for sugar might be pretty close to perfect competition—there could be many firms, those would be the farmers. The suppliers would be many buyers, obviously wanting sugar. There would be some barriers to entry; you would need to know how to grow sugar, you would need suitable land for growing sugar.

But there's a lot of farmers who might be able to swap out either sugarcane or beet, which is where most sugar comes from, with soybean or vice versa. So, they can change which crops they plant. Generally speaking, there's not much differentiation whether you get sugar from one farmer or another, so sugar would be pretty close to perfect competition.

It is the case for a lot of agricultural commodities that they do have to be price takers. There is just a market price that individual farmers have to take—well, I actually want to charge a little bit more for that sugar—because they won't be able to; they're just going to have to take whatever the price is in the market.

Now, as you can imagine, there's a lot of other types of markets that are in between these extremes. Closer to a monopoly and similar to a monopoly in a lot of ways is a situation where you have only a handful of firms, and that's referred to as oligopoly. Oligopoly is a situation where you still have high barriers—so high, high barriers to entry.

You might have a handful of firms, so a few firms and still many buyers. Examples of oligopolies could be things like the aircraft industry, where there are huge barriers to entry; you need to deploy a lot of capital—billions of dollars. You might have to get government approval, and that's why, especially for large aircraft, you only have a few firms that can produce, like Boeing or Airbus.

Those really large aircraft, even in certain cases, automobiles sometimes, computer manufacturers—things that have very, very high barriers to entry. Now, if we go a little bit further to the left, you get a situation that's known as monopolistic competition. Monopolistic—it's fun to say! Competition!

You could view this as right in between, depending on what you're thinking about. This is a situation where there's low barriers to entry—low, low barriers to entry. There are many firms, but you do have differentiation; you do have differentiation.

So, you can tell the product of one firm from another. I can think of many—in fact, most industries I can think of fall roughly into the monopolistic area, although we just mentioned some oligopolies and monopolies. But examples of monopolistic competition I can imagine to be things like cereal—breakfast cereals.

In the breakfast cereal industry, there are many firms; there are generally low barriers—there are some barriers, but they're pretty low—if you want to start a cereal company, a lot of folks might be able to do it. But there is some differentiation; some people might say, “Hey, our cereal is more delicious and sweeter,” while others might say, “Our cereal is more nutritious.”

They build a brand and they do marketing, etc., etc. And because there is some differentiation, there is a little bit more ability for the individual players—unlike in perfect competition—there's a little bit more ability for them to dictate their price. They might say, “Hey, we're a premium product; people think we're healthier, so we might be able to charge a little bit more.”

You can almost imagine that they have their own unique demand curve because of that differentiation. You can imagine the market in something like shirts—that's another example where a lot of folks can produce shirts, but some people might be able to differentiate themselves. They're more stylish, there's better quality; they advertise and build a brand.

So, once again, that would be monopolistic competition. So, anyway, the big picture here is really just for you to get familiar with these words, what do they mean, and in what context or what will they imply about the differentiation or the number of firms? Actually, before I leave, I'll throw out one other word that you'll hear a little bit less than what I just talked about, and it sounds like “monopoly,” but it is “monopsony.”

I'm going to do this in a unique color here—let me see, I haven't done anything in this salmon yet. Sunny! You won't hear it as much as monopoly, and it's really the opposite situation. Instead of one supplier and many buyers, a monopsony is one big buyer and many suppliers.

So, for example, if you have one big box store in a small town, and so they're the only employer in that town, they might have monopsony in the labor market where they're the only people who can hire, and there's a lot of people who are looking for jobs. But we could talk more about that in other videos.