Types of markets

Economics · Microeconomic decision-makers. The idea in plain words, the rules to remember, the mistake to avoid and a worked example, written and checked by Mega Lecture.

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The idea

A competitive market has many firms selling similar products, and new firms can enter easily. No single firm can control the price, so firms must keep prices low and quality high to hold on to customers. Consumers get more choice. High profits attract new firms, so they do not last.

A monopoly is a market with a single seller. Barriers to entry keep rivals out, so the firm can restrict supply and charge a higher price. Choice is less, quality may be lower, and high profits can continue in the long run.

Monopoly is not always bad. A large firm gains economies of scale and can use its profits for research and new products.

Rules to remember

Competitive market: many buyers and sellers, similar products, easy entry and exit, each firm has little influence over price
Many firms: lower prices, better quality, more choice, lower profit for each firm
One firm: higher prices, less choice, possibly lower quality, high profits that last
Pure monopoly: a single firm supplies the whole output of the market
Barriers to entry: patents and licences, high set-up costs, economies of scale, brand loyalty, control of a vital resource
For monopoly: economies of scale can lower costs, profits can pay for research, and it avoids wasteful duplication (e.g. one set of water pipes)
Against very competitive markets: firms are small, so they gain few economies of scale and have little money for research

Common mistake

Writing that a monopoly can charge any price it likes. It is still limited by demand: if it raises the price, it sells fewer units.

Worked example

For years the law allowed only one airline to fly between two cities. The law is removed and three new airlines start flying the route. What is likely to happen to fares, choice, service quality and the first airline's profit?

A legal barrier to entry has gone, so the market changes from a monopoly to a competitive market.
Each airline must now win passengers from rivals, so fares fall and service quality improves.
Passengers can choose between four airlines and more flight times, so choice rises.
The first airline loses customers and must charge less, so its profit falls.

Answer: Fares fall, choice and quality rise, and the first airline's profit falls.

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