By Leigh Richards Updated March 06, 2019
In market economies, there are a variety of different market systems that exist, depending on the industry and the companies within that industry. It is important for small business owners to understand what type of market system they are operating in when making pricing and production decisions, or when determining whether to enter or leave a particular industry.
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The five major market system types are Perfect Competition, Monopoly, Oligopoly, Monopolistic Competition and Monopsony.
Perfect Competition with Infinite Buyers and Sellers
Perfect competition is a market system characterized by many different buyers and sellers. In the classic theoretical definition of perfect competition, there are an infinite number of buyers and sellers. With so many market players, it is impossible for any one participant to alter the prevailing price in the market. If they attempt to do so, buyers and sellers have infinite alternatives to pursue.
Monopoly with One Producer
A monopoly is the exact opposite form of market system as perfect competition. In a pure monopoly, there is only one producer of a particular good or service, and generally no reasonable substitute. In such a market system, the monopolist is able to charge whatever price they wish due to the absence of competition, but their overall revenue will be limited by the ability or willingness of customers to pay their price.
Oligopoly with a Handful of Producers
An oligopoly is similar in many ways to a monopoly. The primary difference is that rather than having only one producer of a good or service, there are a handful of producers, or at least a handful of producers that make up a dominant majority of the production in the market system. While oligopolists do not have the same pricing power as monopolists, it is possible, without diligent government regulation, that oligopolists will collude with one another to set prices in the same way a monopolist would.
Monopolistic Competition with Numerous Competitors
Monopolistic competition is a type of market system combining elements of a monopoly and perfect competition. Like a perfectly competitive market system, there are numerous competitors in the market. The difference is that each competitor is sufficiently differentiated from the others that some can charge greater prices than a perfectly competitive firm.
An example of monopolistic competition is the market for music. While there are many artists, each artist is different and is not perfectly substitutible with another artist.
Monopsony with One Buyer
Market systems are not only differentiated according to the number of suppliers in the market. They may also be differentiated according to the number of buyers. Whereas a perfectly competitive market theoretically has an infinite number of buyers and sellers, a monopsony has only one buyer for a particular good or service, giving that buyer significant power in determining the price of the products produced.
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The article discusses five major market system types:
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Perfect Competition with Infinite Buyers and Sellers:
- Characteristics: In this market system, there are numerous buyers and sellers. The theoretical definition assumes an infinite number of participants.
- Impact on Pricing: No single participant can influence the market price due to the abundance of alternatives for buyers and sellers.
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Monopoly with One Producer:
- Characteristics: Monopoly is the opposite of perfect competition. In this system, there is only one producer for a specific good or service, with no reasonable substitutes.
- Pricing Power: The monopolist can set prices without competition but is limited by the willingness of customers to pay.
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Oligopoly with a Handful of Producers:
- Characteristics: Oligopoly shares similarities with a monopoly but involves a small number of producers dominating the market.
- Pricing Dynamics: Oligopolists may collude to set prices, potentially impacting the market similarly to a monopoly, especially in the absence of strict government regulation.
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Monopolistic Competition with Numerous Competitors:
- Characteristics: This market system combines elements of both monopoly and perfect competition. There are numerous competitors, but each offers differentiated products.
- Pricing Variation: Some competitors can charge higher prices due to product differentiation. An example is the music market, where artists have unique offerings.
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Monopsony with One Buyer:
- Characteristics: Monopsony is differentiated by the number of buyers rather than sellers. It involves only one buyer for a particular good or service.
- Buyer Power: The sole buyer holds significant influence in determining product prices, given the absence of competition among buyers.
Understanding these market systems is crucial for small business owners when making pricing, production, and industry entry/exit decisions. Each system poses unique challenges and opportunities, emphasizing the importance of adapting strategies based on the prevailing market structure. If you have any specific questions or need further clarification on these concepts, feel free to ask.
