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Perfect and imperfect competition

The most common forms of competition you learn about in microeconomics are perfect competition, monopolies, oligopoly, monopsony, and monopolistic competition. In this video we briefly describe the key features of each.

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Video transcript

- [Instructor] 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 'cause you'll hear words like perfect competition or 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. Resource markets. Now product market is a market where the output of that market, what the market is producing or what it's buying and selling it is something that people will consume and it doesn't just have to be physical product it could also be some type of a service. So examples of product markets, it could be the market for shirts, it could be cars or it could even be a service. It could be tax preparation, tax preparation. These would all be product markets because it's something that people would consume. I would call this consumer tax preparation, not business tax preparations. 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 of or factors of production. It could be, for example, the market of labor. It could be something like farm land. Where farm land 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 in the market and how much control they have over the price and how are the barriers to entry. Let's set up a spectrum here to explore that a little bit. So I will set up a spectrum. Now the extreme end of the spectrum right over here, when you only have one player, one player in the market. In the market, or actually let me just say one firm. Because player's not really clear on what I'm talking about whether I'm talking about a buyer or seller. One firm in market. And let's say, many buyers. 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 name for a famous game because the 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. High barriers, barriers to entry. And 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 the intellectual property or through patents, for example a drug company if it discovers a cure for a drug or something to maintain a drug, well they might be granted a monopoly for that pill for some period of time and the government does that so that they can recoup their investment in all of the R&D that they actually produced. What often is illegal in a lot of countries, is if 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 is no barriers. No barriers to entry. Now let's say that there is 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. And actually let me say many firms and many buyers. And many buyers. Now this is a state that we'll often study in our economics class, we'll call it perfect competition. Perfect competition. In a perfect competition world, the firms are essentially have to be price takers. They take whatever the market price is and we have 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's 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. So the market for sugar might be pretty close to perfect competition. There could be many firms, those would be the farmers, the suppliers. It would be many buyers obviously who want sugar. There would be some barriers to entry. You'd 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 sugar cane or beet, which is where most sugar comes from. With soy bean or vice versa. So they can change which crops they plant and generally speaking, there's not much differentiation whether you get sugar from one farm or another. So sugar would be pretty close to perfect competition and 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 the individual farmer is gonna say, oh actually I wanna 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 is 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 oligopoly. And this is a situation where you still have high barriers. So high barriers to entry. You might have a handful of firms, so a few firms and you still have many buyers. Examples of oligopolies, this could be things like the aircraft industry. Air craft. Where there's huge barriers of entry. You need to deploy a lot of capital billions of dollars. You might have to get government approval and so 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 high barriers to entry. If we go a little bit further to the left, you get a situation that's known as monopolistic competition. Monopolistic, that's fun to say, competition. And this you could view 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's many firms. Many firms. But you do have differentiation. You do have differentiation so you can tell the product of one firm for another. And I can think of many, in fact most industries I can think of fall roughly in the monopolistic area. Although we've just mention some oligopolies and monopolies. But examples of monopolistic competition, I can imagine to be things like, cereal, breakfast cereals and the breakfast cereal industry, there is many firms. There's generally low barriers. There's 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 say hey our cereal is more delicious and it's sweeter while others say our cereal is more nutritious and they build a brand and they do marketing, etc, etc. And because there is some differentiation, there's 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, well 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, they build a brand. And 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 then what context or what will they imply about the differentiation or the number of firms? And 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. And I'm gonna do this in a unique color here. Let me see, I haven't done anything in this salmon yet. Monopsony. Which 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 can talk more about that in other videos.