General Economic Models

General Economic Considerations


Conditions of Competition


Economists of the classical school speak of a competitive scale that includes three fundamental types of competition: pure, imperfect, and monopoly. At one end of the scale is pure competition. Under conditions of pure competition, the forces of supply and demand alone, not the individual actions of buyers or sellers, determine prices. In this environment, producers are price takers: They have no control over the price they receive for their products.


At the other end of the competitive scale is monopoly. Under conditions of a monopoly, one seller controls the entire supply of a particular commodity and thus is free to maximize its profit by regulating output and forcing a supply-demand relationship that is most favorable to the seller. In this environment, producers are price makers and exert varying degrees of control over the price they receive for their products.


The competitive are between the extremes of pure competition and monopoly is called imperfect competition. Imperfect competition takes two forms: (1) markets characterized by few sellers and (2) those in which many sellers operate. When there are just a few sellers, an oligopoly is said to exist. The automobile, steel, and tobacco industries are examples of oligopolies. Generally, oligopolistic firms produce relatively few different products.


In contrast to oligopolies, the second form of imperfect competition exists when many sellers produce many products. This form of competition is referred to as monopolistic competition. Most of the products sold on this market are differentiated, although some are not. Sellers, however, spend large sums on major promotional efforts to persuade buyers that their products are different. The majority of the products sold in the United States are traded in this market.


In practice, the three categories of competition are not mutually exclusive; that is, they can overlap. When one considers both the buying side and the selling side of the total market, it is apparent that the number of market arrangements between individual buyers and sellers is very large.


It frequently is suggested that oligopolists conspire and act together as monopolists to thwart price competition. In fact, the U.S. Department of Justice does uncover a few conspiracies every year. The facts, however, indicate that price conspiracies among oligopolists are not the normal order of business. Any buyer who has purchased in oligopilistic markets knows that both price and service competition can be intense. Chevrolet strives intensely to outsell Ford, and vise versa. This is not to say that oligopolistic industries do not periodically exercise monopolistic tendencies to their own advantage. They do. For example, in times of recession, it requires only a basic knowledge of economics, not a conspiracy, for oligopolies to lower production rates and thus direct a balance of the forces of supply and demand in their favor.


It should be noted that oligopostic industries frequently hold firmly to their prices for long periods and appear to be non competitive. This appearance may be deceptive, however. Frequently, to gain a competitive advantage without notice, oligopolists shift their competitive efforts to other areas, such as service. Sellers may agree to perform additional services such as carrying customers’ inventories, extending the payment time of their bills, and absorbing their freight charges. Those indirect price reductions often are not advertised.


Consequently, the amount of service a firm is able to obtain usually correlates directly with the perception and skills of its supply management personnel. Foreign competitors also greatly influence the freedom of U.S. oligopolies to raise their prices above fair market prices. For example, the freedom of U.S. automobile, steel, and electronic companies to raise prices is noticeably restrained because of foreign imports. For a number of items, specialty suppliers also compete effectively with oligopolistic industries can influence a firm’s total cost of materials.


It is important to understand that oligopoly is not characteristic of industry as a whole. Most firms and industries operate somewhere in the area of imperfect competition. Millions of people, working in thousands of factories, produce hundreds of thousands of products substantially without governmental or any other outside direction. The firms that make up this market exercise almost complete control over their prices, and price conspiracies in this market are extremely rare. In fact, aside from utilities, transportation, and some manufacturing industries, the concentration of oligopolistic power is rare.