9781118041581

purchased $200 worth of each metal at 1981 prices. Then the two sides waited and watched price

movements over the next 10 years.

What can the economics of supply and demand tell us about this debate (and this bet)? If the

bet were to be made today, which side would you take?

284 Chapter 7 Perfect Competition

This chapter and the three that follow focus on the spectrum of industry

structures. Markets are typically divided into four main categories: perfect

competition, monopolistic competition, oligopoly, and pure monopoly.

Table 7.1 provides a preview of these different settings by considering two

dimensions of competition: the number of competing firms and the extent

of entry barriers. At one extreme (the lower right cell of the table) is the case

of perfect competition. Such a market is supplied by a large number of com-

petitors. Because each firm claims only a very small market share, none has

the power to control price. Rather, price is determined by supply and

demand. As important, there are no barriers preventing new firms from

entering the market.

At the other extreme (the upper left cell of the table) lies the case of pure

monopoly. Here a single firm supplies the market and has no direct competi-

tors. Thus, as we shall see, the monopolist (if not constrained) has the ultimate

power to raise prices and maximize its profit. Clearly, prohibitive entry barri-

ers are a precondition for pure monopoly. Such barriers prevent rival firms

from entering the market and competing evenhandedly with the incumbent

monopolist.

Oligopoly (shown in the second row of Table 7.1) occupies a middle

ground between the perfectly competitive and monopolistic extremes. In an

oligopoly, a small number of large firms dominate the market. Each firm

must anticipate the effect of its rivals’ actions on its own profits and attempt

to fashion profit-maximizing decisions in response. Again, moderate or high-

entry barriers are necessary to insulate the oligopolists from would-be

entrants.

TABLE 7.1

Comparing Market Structures

Entry Barriers

High Moderate None

One Monopoly Not Applicable

Number

of Firms Few Oligopoly

Very Many

Not Perfect

Applicable Competition

c07PerfectCompetition.qxd 9/29/11 1:30 PM Page 284