Module 58: Introduction to Perfect Competition

Module 59: Graphing Perfect Competition

Module 60: Long-Run Outcomes in Perfect Competition

Module 61: Introduction to Monopoly

Module 62: Monopoly and Public Policy

Module 63: Price Discrimination

Economics by Example: “Is Adam Smith Rolling Over in His Grave?”

Section 10 explained how factors including the number of firms in the industry, the type of product sold, and the existence of barriers to entry determine the market power of firms. We can think about the four basic market structures as falling along a spectrum from perfect competition at one end to monopoly at the other, with monopolistic competition and oligopoly lying in between. To shed more light on the market structure spectrum, consider two very different markets introduced in previous sections: the market for organic tomatoes and the market for diamonds.

In the United States, a growing interest in healthy living has steadily increased the demand for products such as organically grown fruits and vegetables. Over the past decade, the markets for these products have been healthy as well, with an average growth rate of 20% per year. It costs a bit more to grow crops without chemical fertilizers and pesticides, but consumers are willing to pay higher prices for the benefits of fruits and vegetables grown the natural way. The farmers in each area who pioneered organic farming techniques had little competition and many prospered thanks to these higher prices.

But with profit as a lure for expanded production, the high prices were unlikely to persist. Over time, farmers already producing organically would increase their capacity, and conventional farmers would enter the organic food fray, increasing supply and driving down price. With a large and growing number of buyers and sellers, undifferentiated products, and few barriers to entry, the organic food market increasingly resembles a perfectly competitive market.

In contrast, the market for diamonds is dominated by one supplier, De Beers. For generations, diamonds have been valued not just for their attractive appearance, but also for their rarity. But geologists will tell you that diamonds aren’t all that rare. In fact, they are fairly common and only seem rare compared to other gem-quality stones. This is because De Beers makes them rare: the company controls most of the world’s diamond mines and limits the quantity supplied to the market. This makes De Beers resemble a monopolist, the sole producer of a good. Because De Beers controls so much of the world’s diamond supply, other firms have considerable difficulty trying to enter the diamond market and increase the quantity of the gems available.

In this section we will study how markets like those for organic tomatoes and diamonds differ, and how these markets respond to market conditions. We will see how firms positioned at opposite ends of the spectrum of market power—from perfect competition to monopoly—make key decisions about output and prices. Then, in Section 12, we will complete our exploration of market structure with a closer look at oligopoly and monopolistic competition.