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What Is Perfect Competition?

The term perfect competition refers to a theoretical market structure. Although perfect competition rarely occurs in real-world markets, it provides a useful model for explaining how supply and demand affect prices and behavior in a market economy.

Under perfect competition, there are many buyers and sellers, and prices reflect supply and demand. Companies earn just enough profit to stay in business and no more. If they were to earn excess profits, other companies would enter the market and drive profits down.

How Perfect Competition Works

Perfect competition is a benchmark or ideal type to which real-life market structures can be compared. Perfect competition is theoretically the opposite of a monopoly, in which only a single firm supplies a good or service and that firm can charge whatever price it wants since consumers have no alternatives and it is difficult for would-be competitors to enter the marketplace.

In a perfect competition model, there are no monopolies. This kind of structure has a number of key characteristics, including:

All firms sell an identical product (the product is a commodity or homogeneous).

All firms are price takers (they cannot influence the market price of their products).

Market share has no influence on prices.

Buyers have complete or perfect information (in the past, present, and future) about the product being sold and the prices charged by each firm.

Capital resources and labor are perfectly mobile.

Firms can enter or exit the market without cost.

This can be contrasted with the more realistic imperfect competition, which exists whenever a market, hypothetical or real, violates the abstract tenets of neoclassical pure or perfect competition.

Since all real markets exist outside of the plane of the perfect competition model, each can be classified as imperfect. The contemporary theory of imperfect versus perfect competition stems from the Cambridge tradition of post-classical economic thought.

Characteristics of Perfect Competition

A perfectly-competitive market is defined by the following factors:

A Large and Homogeneous Market

There are a large number of buyers and sellers in a perfectly competitive market. The sellers are small firms, instead of large corporations capable of controlling prices through supply adjustments. They sell products with minimal differences in capabilities, features, and pricing. This ensures that buyers cannot distinguish between products based on physical attributes, such as size or color, or intangible values, such as branding.

A large population of both buyers and sellers ensures that supply and demand remain constant in this market. As such, buyers can easily substitute products made by one firm for another.

Perfect Information Availability

Information about an industry's ecosystem and competition constitutes a significant advantage. For example, knowledge about component sourcing and supplier pricing can make or break the market for certain companies.

In certain knowledge and research-intensive industries, such as pharmaceuticals and technology, information about patents and research initiatives at competitors can help companies develop competitive strategies and build a moat around their products.

Absence of Controls

Governments play a vital role in market formation for products by imposing regulations and price controls. They can control the entry and exit of firms into a market by setting up rules to function in the market. For example, the pharmaceutical industry has to contend with a roster of rules pertaining to the development, production, and sale of drugs.

In turn, these rules require big capital investments in the form of employees, such as lawyers and quality assurance personnel, and infrastructure, such as machinery to manufacture medicines. The cumulative costs add up and make it extremely expensive for companies to bring a drug to the market.

In comparison, the technology industry functions with relatively less oversight as compared to its pharma counterpart. Thus, entrepreneurs in this industry can start firms with less to zero capital, making it easy for individuals to start a company in the industry.

Such controls do not exist in a perfectly competitive market. The entry and exit of firms in such a market are unregulated, and this frees them up to spend on labor and capital assets without restrictions and adjust their output in relation to market demands.

Cheap and Efficient Transportation

Cheap and efficient transportation is another characteristic of perfect competition. In this type of market, companies do not incur significant costs to transport goods. This helps reduce the product's price and cuts back on delays in transporting goods.

Theory vs. Reality of Perfect Competition

Real-world competition differs from this ideal primarily because of differentiation in production, marketing, and selling. For example, the owner of a small organic products shop can advertise extensively about the grain fed to the cows that made the manure that fertilized the non-GMO soybeans, thereby setting their product apart from competitors. This is what's called differentiation.

The first two criteria (homogeneous products and price takers) are far from realistic. Yet, for the second two criteria (information and mobility) the global tech and trade transformation is improving information and resource flexibility. While the reality is far from this theoretical model, the model is still helpful because of its ability to explain many real-life behaviors.

Barriers to Entry Prohibit Perfect Competition

Many industries also have significant barriers to entry, such as high startup costs (as seen in the auto manufacturing industry) or strict government regulations (as seen in the utility industry), which limit the ability of firms to enter and exit such industries. And although consumer awareness has increased with the information age, there are still few industries where the buyer remains aware of all available products and prices.

Significant obstacles exist that prevent perfect competition from developing in the economy. The agricultural industry probably comes closest to exhibiting perfect competition because it is characterized by many small producers with virtually no ability to alter the selling price of their products.

The commercial buyers of agricultural commodities are generally very well-informed and, although agricultural production involves some barriers to entry, it is not particularly difficult to enter the marketplace as a producer.

Advantages and Disadvantages of Perfect Competition

Perfect competition is an idealized framework for a market economy. While it provides a convenient model for how an economy works, it is not always accurate and has significant departures from the real-world economy. Like with other models, the value of a perfect competition framework is only accurate to the extent that it reflects actual conditions.

One notable feature of perfect competition is low profit margins. Since all consumers have access to the same products, they naturally gravitate towards the lowest prices. Firms cannot set themselves apart by charging a premium for higher-quality products and services. For instance, it would be impossible for a company like Apple ( AAPL) to exist in a perfectly competitive market because its phones are more expensive than those of its competitors.

Another is the absence of innovation. The prospect of greater market share and setting themselves apart from the competition is an incentive for firms to innovate and make better products. But no firm possesses a dominant market share in perfect competition, meaning that the long-term profitability of their operations is zero.

Another disadvantage is the absence of economies of scale. Limited to zero profit margins means that companies will have less cash to invest in expanding their production capabilities. An expansion of production capabilities could potentially bring down costs for consumers and increase business profit margins. But the presence of several small firms cannibalizing the market for the same product prevents this and ensures that the average firm size remains small.

Do Firms Profit in Perfect Competition?

Profits may be possible for brief periods in perfectly competitive markets. But the market's dynamics cancel out the effects of positive or negative profits and bring them toward an equilibrium. Because there is no information asymmetry in the market, other firms will quickly ramp up their production or reduce their manufacturing costs to achieve parity with the firm which made profits.

The average revenue and marginal revenue for firms in a perfectly competitive market are equal to the product's price to the buyer. As a result, the perfectly competitive market's equilibrium, which had been disrupted earlier, will be restored. In the long run, an adjustment of supply and demand ensures all profits or losses in such markets tend toward zero.

Perfect Competition vs. Monopoly

The opposite of perfect competition is a monopoly, where a single company controls the supply of a certain product. In monopoly conditions, consumers cannot go elsewhere if the price is too high; they can only decide not to buy the product.

This means that rather than setting prices by supply and demand, the monopolistic firm can simply set a price point that maximizes its profits. Some types of firms are considered natural monopolies because there is a significant first-mover advantage that discourages competitors from entering the market. Other monopolies may be established through government actions, or by cartels, such as OPEC.

Examples of Perfect Competition

As mentioned earlier, perfect competition is a theoretical construct and doesn't actually exist. As such, it is difficult to find real-life examples of perfect competition but there are variants present in everyday society.

Consider the situation at a farmer's market, a place characterized by a large number of small sellers and buyers. There is typically little differentiation between products and their prices from one farmer's market to another. How the produce is grown does not matter (unless they are classified as organic) and there is very little difference in how they're packaged or branded. Thus, even if one of the farms producing goods for the market goes out of business, it will not make a difference to average prices.

Supermarkets

The situation may also be relatively similar in the case of two competing supermarkets, which stock their aisles from the same set of companies. Again, there is little to distinguish products from one another between both supermarkets and their pricing remains almost the same. Another example of perfect competition is the market for unbranded products, which features cheaper versions of well-known products.

Product knockoffs are generally priced similarly and there is little to differentiate them from one another. If one of the firms manufacturing such a product goes out of business, it is replaced by another one.

Technology

The development of new markets in the technology industry also resembles perfect competition to a certain degree. For example, there was a proliferation of sites offering similar services during the early days of social media networks. Some examples of such sites are Sixdegrees.com, Blackplanet.com, and Asianave.com. None of them had a dominant market share and the sites were mostly free. They constituted sellers in the market while consumers of such sites, who were mainly young people, were the buyers.

The startup costs for companies in this space were minimal, meaning that startups and companies can freely enter and exit these markets. Technologies, such as PHP and Java, were largely open-source and available to anyone. Capital costs, in the form of real estate and infrastructure, were not necessary. Remember that Mark Zuckerberg effectively founded Facebook from his college dorm.

What Is Perfect Competition?

What Is an Example of Perfect Competition?

What Is the Difference Between Perfect Competition and Imperfect Competition?

The Bottom Line

Perfect competition describes an imaginary market condition where all consumers have access to the same products and information. In this type of economy, all firms must offer the lowest price possible or risk being undercut by their competitors. Although this is only a theoretical model, perfect competition is useful for demonstrating how economic actors behave in a free market.

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Perfect Competition: Examples and How It Works

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Pure or perfect competition is a theoretical market structure in which a number of criteria such as perfect information and resource mobility are met.

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- Its easier for newcomers
- homogenous products
- price its set by supply and demand

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Monopolistic competition

The model of monopolistic competition describes a common market structure in which firms have many competitors, but each one sells a slightly different product.

Monopolistic competition as a market structure was first identified in the 1930s by American economist Edward Chamberlin, and English economist Joan Robinson.

Many small businesses operate under conditions of monopolistic competition, including independently owned and operated high-street stores and restaurants. In the case of restaurants, each one offers something different and possesses an element of uniqueness, but all are essentially competing for the same customers.

Characteristics

Monopolistically competitive markets exhibit the following characteristics:

1. Each firm makes independent decisions about price and output, based on its product, its market, and its costs of production.

2. Knowledge is widely spread between participants, but it is unlikely to be perfect. For example, diners can review all the menus available from restaurants in a town, before they make their choice. Once inside the restaurant, they can view the menu again, before ordering. However, they cannot fully appreciate the restaurant or the meal until after they have dined.

3. The entrepreneur has a more significant role than in firms that are perfectly competitive because of the increased risks associated with decision making.

4. There is freedom to enter or leave the market, as there are no major barriers to entry or exit.

5. A central feature of monopolistic competition is that products are differentiated. There are four main types of differentiation:

Physical product differentiation, where firms use size, design, colour, shape, performance, and features to make their products different. For example, consumer electronics can easily be physically differentiated.

Marketing differentiation, where firms try to differentiate their product by distinctive packaging and other promotional techniques. For example, breakfast cereals can easily be differentiated through packaging.

Human capital differentiation, where the firm creates differences through the skill of its employees, the level of training received, distinctive uniforms, and so on.

Differentiation through distribution, including distribution via mail order or through internet shopping, such as Amazon.com, which differentiates itself from traditional bookstores by selling online.

6. Firms are price makers and are faced with a downward sloping demand curve. Because each firm makes a unique product, it can charge a higher or lower price than its rivals. The firm can set its own price and does not have to 'take' it from the industry as a whole, though the industry price may be a guideline, or becomes a constraint. This also means that the demand curve will slope downwards.

7. Firms operating under monopolistic competition usually have to engage in advertising. Firms are often in fierce competition with other (local) firms offering a similar product or service, and may need to advertise on a local basis, to let customers know their differences. Common methods of advertising for these firms are through local press and radio, local cinema, posters, leaflets and special promotions.

8. Monopolistically competitive firms are assumed to be profit maximisers because firms tend to be small with entrepreneurs actively involved in managing the business.

9. There are usually a large numbers of independent firms competing in the market.

Equilibrium under monopolistic competition

In the short run supernormal profits are possible, but in the long run new firms are attracted into the industry, because of low barriers to entry, good knowledge and an opportunity to differentiate.

Monopolistic competition in the short run

At profit maximisation, MC = MR, and output is Q and price P. Given that price (AR) is above ATC at Q, supernormal profits are possible (area PABC).

As new firms enter the market, demand for the existing firm's products becomes more elastic and the demand curve shifts to the left, driving down price. Eventually, all super-normal profits are eroded away.

Monopolistic competition in the long run

Super-normal profits attract in new entrants, which shifts the demand curve for existing firm to the left. New entrants continue until only normal profit is available. At this point, firms have reached their long run equilibrium.

Clearly, the firm benefits most when it is in its short run and will try to stay in the short run by innovating, and further product differentiation.

Examples of monopolistic competition

Examples of monopolistic competition can be found in every high street.

Monopolistically competitive firms are most common in industries where differentiation is possible, such as:

The survival of small firms

The existence of monopolistic competition partly explains the survival of small firms in modern economies. The majority of small firms in the real world operate in markets that could be said to be monopolistically competitive.

Evaluation

The advantages of monopolistic competition

Monopolistic competition can bring the following advantages:

1. There are no significant barriers to entry; therefore markets are relatively contestable.

2. Differentiation creates diversity, choice and utility. For example, a typical high street in any town will have a number of different restaurants from which to choose.

3. The market is more efficient than monopoly but less efficient than perfect competition - less allocatively and less productively efficient. However, they may be dynamically efficient, innovative in terms of new production processes or new products. For example, retailers often constantly have to develop new ways to attract and retain local custom.

The disadvantages of monopolistic competition

There are several potential disadvantages associated with monopolistic competition, including:

1. Some differentiation does not create utility but generates unnecessary waste, such as excess packaging. Advertising may also be considered wasteful, though most is informative rather than persuasive.

2. As the diagram illustrates, assuming profit maximisation, there is allocative inefficiency in both the long and short run. This is because price is above marginal cost in both cases. In the long run the firm is less allocatively inefficient, but it is still inefficient.

Inefficiency

The firm is allocatively and productively inefficient in both the long and short run.

There is a tendency for excess capacity because firms can never fully exploit their fixed factors because mass production is difficult. This means they are productively inefficient in both the long and short run. However, this is may be outweighed by the advantages of diversity and choice.

As an economic model of competition, monopolistic competition is more realistic than perfect competition - many familiar and commonplace markets have many of the characteristics of this model.

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Oligopoly

Defining and measuring oligopoly

An oligopoly is a market structure in which a few firms dominate. When a market is shared between a few firms, it is said to be highly concentrated. Although only a few firms dominate, it is possible that many small firms may also operate in the market. For example, major airlines like British Airways (BA) and Air France operate their routes with only a few close competitors, but there are also many small airlines catering for the holidaymaker or offering specialist services. Similarly, while the 'Big Six' energy suppliers dominate the UK market, with a combined market share of 78% for electricity supply (according to the energy regulator, Ofcom), there are currently 54 active suppliers. (2017 data).

Concentration ratios

Oligopolies may be identified using concentration ratios, which measure the proportion of total market share controlled by a given number of firms. When there is a high concentration ratio in an industry, economists tend to identify the industry as an oligopoly.

Example of a hypothetical concentration ratio

The following are the annual sales, in £m, of the six firms in a hypothetical market:

A = 56

B = 43

C = 22

D = 12

E = 3

F = 1

In this hypothetical case, the 3-firm concentration ratio is 88.3%, that is 121/137 x 100.

Examples

Fixed Broadband services

Fixed broadband supply in the UK is dominated by four main suppliers - BT (with a market share of 32%), Virgin Media (at 20%), Sky (at 22%) and TalkTalk (at 14%), making a four-firm concentration ratio of 86% (2015). Source: OFCOM .

Fuel retailing

Fuel retailing in the UK is dominated by six major suppliers, including Tesco, BP, Shell, Esso, Morrisons and Sainsbury, as shown below:

Further examples
Cinema attendances Banking
The Herfindahl - Hirschman Index (H-H Index)

This is an alternative method of measuring concentration and for tracking changes in the level of concentration following mergers. The H-H index is found by adding together the squared values of the % market shares of all the firms in the market. For example, if three firms exist in the market the formula is X ² + Y ² + Z ²; where X, Y and Z are the percentages of the three firm's market shares.

If the index is below 1000, the market is not considered concentrated, while an index above 2000 indicates a highly concentrated market or industry - the higher the figure the greater the concentration.

Mergers between oligopolists increase concentration and 'monopoly power' and are likely to be the subject of regulation.

Key characteristics

The main characteristics of firms operating in a market with few close rivals include:

Interdependence

Firms that are interdependent cannot act independently of each other. A firm operating in a market with just a few competitors must take the potential reaction of its closest rivals into account when making its own decisions. For example, if a petrol retailer like Texaco wishes to increase its market share by reducing price, it must take into account the possibility that close rivals, such as Shell and BP, may reduce their price in retaliation. An understanding of game theory and the Prisoner's Dilemma helps appreciate the concept of interdependence.

Strategy

Strategy is extremely important to firms that are interdependent. Because firms cannot act independently, they must anticipate the likely response of a rival to any given change in their price, or their non-price activity. In other words, they need to plan, and work out a range of possible options based on how they think rivals might react.

Oligopolists have to make critical strategic decisions, such as:

Whether to compete with rivals, or collude with them.

Whether to raise or lower price, or keep price constant.

Whether to be the first firm to implement a new strategy, or whether to wait and see what rivals do. The advantages of 'going first' or 'going second' are respectively called 1st and 2nd-mover advantage. Sometimes it pays to go first because a firm can generate head-start profits. 2nd mover advantage occurs when it pays to wait and see what new strategies are launched by rivals, and then try to improve on them or find ways to undermine them.

Barriers to entry

Oligopolies and monopolies frequently maintain their position of dominance in a market might because it is too costly or difficult for potential rivals to enter the market. These hurdles are called barriers to entry and the incumbent can erect them deliberately, or they can exploit natural barriers that exist.

Natural entry barriers include:

Economies of large scale production.

If a market has significant economies of scale that have already been exploited by the incumbents, new entrants are deterred.

Ownership or control of a key scarce resource

Owning scarce resources that other firms would like to use creates a considerable barrier to entry, such as an airline controlling access to an airport.

High set-up costs

High set-up costs deter initial market entry, because they increase break-even output, and delay the possibility of making profits. Many of these costs are sunk costs, which are costs that cannot be recovered when a firm leaves a market, and include marketing and advertising costs and other fixed costs.

High R&D costs

Spending money on Research and Development (R & D) is often a signal to potential entrants that the firm has large financial reserves. In order to compete, new entrants will have to match, or exceed, this level of spending in order to compete in the future. This deters entry, and is widely found in oligopolistic markets such as pharmaceuticals and the chemical industry.

Artificial barriers include:

Predatory pricing

Predatory pricing occurs when a firm deliberately tries to push prices low enough to force rivals out of the market.

Limit pricing

Limit pricing means the incumbent firm sets a low price, and a high output, so that entrants cannot make a profit at that price. This is best achieved by selling at a price just below the average total costs (ATC) of potential entrants. This signals to potential entrants that profits are impossible to make.

Superior knowledge

An incumbent may, over time, have built up a superior level of knowledge of the market, its customers, and its production costs. This superior knowledge can deter entrants into the market.

Predatory acquisition

Predatory acquisition involves taking-over a potential rival by purchasing sufficient shares to gain a controlling interest, or by a complete buy-out. As with other deliberate barriers, regulators, like the Competition and Markets Authority (CMA), may prevent this because it is likely to reduce competition.

Advertising

Advertising is another sunk cost - the more that is spent by incumbent firms the greater the deterrent to new entrants.

A strong brand

A strong brand creates loyalty, 'locks in' existing customers, and deters entry.

Loyalty schemes

Schemes such as Tesco's Club Card, help oligopolists retain customer loyalty and deter entrants who need to gain market share.

Exclusive contracts, patents and licences

These make entry difficult as they favour existing firms who have won the contracts or own the licenses. For example, contracts between suppliers and retailers can exclude other retailers from entering the market.

Vertical integration

Vertical integration can 'tie up' the supply chain and make life tough for potential entrants, such as an electronics manufacturer like Sony having its own retail outlets (Sony Centres), and a brewer like Heineken owning its own chain of UK pubs, which it acquired from the brewers Scottish and Newcastle in 2008.

Another key feature of oligopolistic markets is that firms may attempt to collude, rather than compete. If colluding, participants act like a monopoly and can enjoy the benefits of higher profits over the long term.

Types of collusion

Overt

Overt collusion occurs when there is no attempt to hide agreements, such as the when firms form trade associations like the Association of Petrol Retailers.

Covert

Covert collusion occurs when firms try to hide the results of their collusion, usually to avoid detection by regulators, such as when fixing prices.

Tacit

Tacit collusion arises when firms act together, called acting in concert, but where there is no formal or even informal agreement. For example, it may be accepted that a particular firm is the price leader in an industry, and other firms simply follow the lead of this firm. All firms may 'understand' this, but no agreement or record exists to prove it. If firms do collude, and their behaviour can be proven to result in reduced competition, they are likely to be subject to regulation. In many cases, tacit collusion is difficult or impossible to prove, though regulators are becoming increasingly sophisticated in developing new methods of detection.

When competing, oligopolists prefer non-price competition in order to avoid price wars. A price reduction may achieve strategic benefits, such as gaining market share, or deterring entry, but the danger is that rivals will simply reduce their prices in response.

This leads to little or no gain, but can lead to falling revenues and profits. Hence, a far more beneficial strategy may be to undertake non-price competition.

Pricing strategies of oligopolies

Oligopolies may pursue the following pricing strategies:

1. Oligopolists may use predatory pricing to force rivals out of the market. This means keeping price artificially low, and often below the full cost of production.

2. They may also operate a limit-pricing strategy to deter entrants, which is also called entry forestalling price.

3. Oligopolists may collude with rivals and raise price together, but this may attract new entrants.

4. Cost-plus pricing is a straightforward pricing method, where a firm sets a price by calculating average production costs and then adding a fixed mark-up to achieve a desired profit level. Cost-plus pricing is also called rule of thumb pricing.

There are different versions of cost-pus pricing, including full cost pricing, where all costs - that is, fixed and variable costs - are calculated, plus a mark up for profits, and contribution pricing, where only variable costs are calculated with precision and the mark-up is a contribution to both fixed costs and profits.

Cost-plus pricing is very useful for firms that produce a number of different products, or where uncertainty exists. It has been suggested that cost-plus pricing is common because a precise calculation of marginal cost and marginal revenue is difficult for many oligopolists. Hence, it can be regarded as a response to information failure. Cost-plus pricing is also common in oligopoly markets because it is likely that the few firms that dominate may often share similar costs, as in the case of petrol retailers.

However, there is a risk with such a rigid pricing strategy as rivals could adopt a more flexible discounting strategy to gain market share.

Cost-plus pricing can also be explained through the application of game theory. If one firm uses cost-plus pricing - perhaps the dominant firm with the greatest market share - others may follow-suit so that the strategy becomes a shared one, which acts as a pricing rule. This takes some of the risk out of pricing decisions, given that all firms will abide by the rule. This could be considered a form of tacit collusion.

Non-price strategies

Non-price competition is the favoured strategy for oligopolists because price competition can lead to destructive price wars - examples include:

1. Trying to improve quality and after sales servicing, such as offering extended guarantees.

2. Spending on advertising, sponsorship and product placement - also called hidden advertising - is very significant to many oligopolists. The UK's football Premiership has long been sponsored by firms in oligopolies, including Barclays Bank and Carling.

3. Sales promotion, such as buy-one-get-one-free (BOGOF), is associated with the large supermarkets, which is a highly oligopolistic market, dominated by three or four large chains.

4. Loyalty schemes, which are common in the supermarket sector, such as Sainsbury's Nectar Card and Tesco's Club Card.

Each strategy can be evaluated in terms of:

1. How successful is it likely to be?

2. Will rivals be able to copy the strategy?

3. Will the firms get a 1st - mover advantage?

4. How expensive is it to introduce the strategy? If the cost of implementation is greater than the pay-off, clearly it will be rejected.

5. How long will it take to work? A strategy that takes five years to generate a pay-off may be rejected in favour of a strategy with a quicker pay-off.

Price stickiness

The theory of oligopoly suggests that, once a price has been determined, will stick it at this price. This is largely because firms cannot pursue independent strategies. For example, if an airline raises the price of its tickets from London to New York, rivals will not follow suit and the airline will lose revenue - the demand curve for the price increase is relatively elastic. Rivals have no need to follow suit because it is to their competitive advantage to keep their prices as they are.

However, if the airline lowers its price, rivals would be forced to follow suit and drop their prices in response. Again, the airline will lose sales revenue and market share. The demand curve is relatively inelastic in this context.

Kinked demand curve

The reaction of rivals to a price change depends on whether price is raised or lowered. The elasticity of demand, and hence the gradient of the demand curve, will be also be different. The demand curve will be kinked, at the current price.

Even when there is a large rise in marginal cost, price tends to stick close to its original, given the high price elasticity of demand for any price rise.

At price P, and output Q, revenue will be maximised.

Maximising profits

If marginal revenue and marginal costs are added it is possible to show that profits will also be maximised at price P. Profits will always be maximised when MC = MR, and so long as MC cuts MR in its vertical portion, then profit maximisation is still at P. Furthermore, if MC changes in the vertical portion of the MR curve, price still sticks at P. Even when MC moves out of the vertical portion, the effect on price is minimal, and consumers will not gain the benefit of any cost reduction.

A game theory approach to price stickiness

Pricing strategies can also be looked at in terms of game theory; that is in terms of strategies and payoffs. There are three possible price strategies, with different pay-offs and risks:

Raise price

Lower price

Keep price constant

The choice of strategy will depend upon the pay-offs, which depends upon the actions of competitors. Raising price or lowering price could lead to a beneficial pay-off, but both strategies can lead to losses, which could be potentially disastrous. In short, changing price is too risky to undertake.

Therefore, although keeping price constant will not lead to the single best outcome, it may be the least risky strategy for an oligopolist.

The Prisoner's Dilemma

Game theory also predicts that:

There is a tendency for cartels to form because co-operation is likely to be highly rewarding. Co-operation reduces the uncertainty associated with the mutual interdependence of rivals in an oligopolistic market. While cartels are 'unlawful' in most countries, they may still operate, with members concealing their unlawful behaviour.

Cartels are designed to protect the interests of members, and the interests of consumers may suffer because of:

1. Higher prices or hidden prices, such as the hidden charges in credit card transactions

2. Lower output

3. Restricted choice or other limiting conditions associated with the transaction

A classic game called the Prisoner's Dilemma is often used to demonstrate the interdependence of oligopolists.

Examples of Oligopoly

Oligopolies are common in the airline industry, banking, brewing, soft-drinks, supermarkets and music. For example, the manufacture, distribution and publication of music products in the UK, as in the EU and USA, is highly concentrated, with a 4-firm concentration ratio of around 75%, and is usually identified as an oligopoly.

The key players in 2011 were:

Music Market Shares

Music market shares Master | amCharts

Evaluation of oligopolies

Oligopolies are significant because they generate a considerable share of the UK's national income, and they dominate many sectors of the UK economy.

The disadvantages of oligopolies

Oligopolies can be criticised on a number of obvious grounds, including:

1. High concentration reduces consumer choice.

2. Cartel-like behaviour reduces competition and can lead to higher prices and reduced output.

3. Given the lack of competition, oligopolists may be free to engage in the manipulation of consumer decision making. By making decisions more complex - such as financial decisions about mortgages - individual consumers fall back on heuristics and rule of thumb processes, which can lead to decision making bias and irrational behaviour, including making purchases which add no utility or even harm the individual consumer.

4. Firms can be prevented from entering a market because of deliberate barriers to entry.

5. There is a potential loss of economic welfare.

6. Oligopolists may be allocatively and productively inefficient.

Oligopolies tend to be both allocatively and productively inefficient. At profit maximising equilibrium, P, prce is above MC, and output, Q, is less than the productively efficient output, Q1, at point A.

The advantages of oligopolies

However, oligopolies may provide the following benefits:

1. Oligopolies may adopt a highly competitive strategy, in which case they can generate similar benefits to more competitive market structures, such as lower prices. Even though there are a few firms, making the market uncompetitive, their behaviour may be highly competitive.

2. Oligopolists may be dynamically efficient in terms of innovation and new product and process development. The super-normal profits they generate may be used to innovate, in which case the consumer may gain.

3. Price stability may bring advantages to consumers and the macro-economy because it helps consumers plan ahead and stabilises their expenditure, which may help stabilise the trade cycle.

See Transfer pricing

See Browser market shares

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An oligopoly is a market structure in which a few firms dominate. When a market is shared between a few firms, it is said to be highly concentrated. Although only a few firms dominate, it is possible that many small firms may also operate in the market.

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What is Monopoly? Definition of Monopoly, Monopoly Meaning - The Economic Times

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Monopoly definition - What is meant by the term Monopoly ? meaning of IPO, Definition of Monopoly on The Economic Times.

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Utilites such as Duke Energy,  Water and infrastructure such as a bridge are examples of monopoly, they have  great control over industry

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Restaurants such as Panera Bread, Wendy's, and Chipotle. They essential sell the same product, food, however each business has its own style. EX: bakeries,

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Sometimes cartels can form; a cartel is an agreement by a formal organization of producers to coordinate prices and production which gives them significant control over a market (cartels are illegal in the U.S.)
EX: Pharmicuticles, Cars, Banking, Oil

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Oligopoly describes a market dominated by a few large, profitable firms; economists usually call an industry an oligopoly if the four largest firms produce 70 to 80 percent of the output

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In a monopolistic competition, many companies compete in an open market to sell products that are similar but not identical. Each firm holds a monopoly over its own particular product.

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A monopoly forms when barriers to prevent firms from entering a market that has a single supplier (has only one seller!); monopolies disrupt competition and can cause prices to increase

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Perfect competition is the simplest market structure and sometimes known as “pure competition.”
Ex: Agriculture