In the real world, there is a mind-boggling array of different markets. We observe widely different behaviour patterns by producers across markets: in some markets producers are extremely competitive; in others, they seem somehow to coordinate their actions to avoid competing with one another; and, as we have just described, some markets are monopolies in which there is no competition at all. In order to develop principles and make predictions about markets and how producers will behave in them, economists have developed four principal models of market structure: perfect competition, monopoly, oligopoly, and monopolistic competition.

This system of market structures is based on two dimensions:

Differentiated goods are goods that are different but considered somewhat substitutable by consumers (think Coke versus Pepsi, or an iPhone versus an Android phone).

Figure 13-1 provides a simple visual summary of the types of market structure classified according to the two dimensions. In monopoly, a single producer sells a single, undifferentiated product. In oligopoly, a few producers—more than one but not a large number—sell products that may be either identical or differentiated. In monopolistic competition, many producers each sell a differentiated product (think of producers of economics textbooks). And finally, as we know, in perfect competition many producers each sell an identical product.

You might wonder what determines the number of firms in a market: whether there is one (monopoly), a few (oligopoly), or many (perfect competition and monopolistic competition). We won’t answer that question here because it will be covered in detail later in this chapter and in Chapters 14 and 15, which analyze oligopoly and monopolistic competition. We will just briefly note that in the long run it depends on whether there are conditions that make it difficult for new firms to enter the market, such as control of necessary resources or inputs, increasing returns to scale in production, technological superiority, a network externality, or government regulations. When these conditions are present, industries tend to be monopolies or oligopolies; when they are not present, industries tend to be perfectly competitive or monopolistically competitive.

You might also wonder why some markets have differentiated products but others have identical ones. The answer is that it depends on the nature of the good and consumers’ preferences. Some goods—soft drinks, economics textbooks, breakfast cereals—can readily be made into different varieties in the eyes and tastes of consumers. Other goods—hammers, for example—are much less easy to differentiate.

Although this chapter is devoted to monopoly, important aspects of monopoly carry over to oligopoly and monopolistic competition. In the next section, we will define monopoly and review the conditions that make it possible. These same conditions, in less extreme form, also give rise to oligopoly. We then show how a monopolist can increase profit by limiting the quantity supplied to a market—behaviour that also occurs in oligopoly and monopolistic competition. As we’ll see, this kind of behaviour is good for the producer but bad for consumers; it also causes inefficiency. An important topic of study will be the ways in which public policy tries to limit the damage. Finally, we turn to one of the surprising effects of monopoly—one that is very often present in oligopoly and monopolistic competition as well: the fact that different consumers often pay different prices for the same good.