3.3: Degrees of Competition

In economic theory and the broader discussion of competition, the “types” or “degrees” of competition refer to how firms compete in the market. These classifications focus on the market environment, not direct “business competition” (strategies businesses use to compete).

The Canadian economy is founded on the principles of private enterprise: private property rights, freedom of choice, profits and competition. In a mixed economy, such as Canada, businesses make decisions about which goods to produce or services to offer and how they are priced. Because there are many businesses making goods or providing services, customers can choose from a wide array of products. The competition for sales among businesses is a vital part of our economic system. Competition varies within industries and has a big influence on how companies operate. Porter’s Five Forces model can be used to identify and analyze an industry’s competitive forces. The five forces are: threat of new entrants, threat of substitutes, bargaining power of buyers, bargaining power of suppliers, and rivalry among existing competitors.

As shown in Table 3.1 below, economists have identified four types of competition — perfect competition, monopolistic competition, oligopoly, and monopoly.

Perfect Competition

Perfect competition is a market structure characterized by many buyers and sellers, homogeneous products, and no single participant having market power. Perfect competition exists when there are many consumers buying a standardized product from numerous small businesses. Because no seller is big enough or influential enough to affect the price, sellers and buyers accept the going price. For example, when a commercial fisher brings his fish to the local market, he has little control over the price he gets and must accept the going market price.

Supply and demand are central to the concept of perfect competition. In perfect competition, the price of goods and services is determined entirely by the interaction of supply and demand. High competition ensures that the supply curve (producers) and demand curve (consumers) interact freely without interference, such as monopolistic pricing or government controls. Producers can only compete on efficiency since prices cannot be manipulated, aligning the supply with the true demand.

Monopolistic Competition

In monopolistic competition, we still have many sellers (as we had under perfect competition). Now, however, they do not sell identical products. Instead, they sell differentiated products—products that differ somewhat, or are perceived to differ, even though they serve a similar purpose. Products can be differentiated in a number of ways, including quality, style, convenience, location, and brand name. Some people prefer Coke over Pepsi, even though the two products are quite similar. But what if there was a substantial price difference between the two? In that case, buyers could be persuaded to switch from one to the other. Thus, if Coke has a big promotional sale at a supermarket chain, some Pepsi drinkers might switch (at least temporarily).

How is product differentiation accomplished? Sometimes, it’s simply geographical; you probably buy gasoline at the station closest to your home, regardless of the brand. At other times, perceived differences between products are promoted by advertising designed to convince consumers that one product is different from and better than another. Regardless of customer loyalty to a product, if its price goes too high, the seller will lose business to a competitor. Under monopolistic competition, therefore, companies have only limited control over price.

Oligopoly

Oligopoly means a few sellers. In an oligopolistic market, each seller supplies a large portion of all the products sold in the marketplace. In addition, because the cost of starting a business in an oligopolistic industry is usually high, the number of firms entering it is low. Companies in oligopolistic industries include such large-scale enterprises as automobile companies and airlines. As large firms that supply a sizable portion of a market, these companies have some control over the prices they charge. But there’s a catch: because products are fairly similar, when one company lowers prices, others are often forced to follow suit to remain competitive. You see this practice all the time in the grocery sector—when one chain offers discounts or promotions, others typically follow suit to attract customers and maintain market share.

Monopoly

In terms of the number of sellers and degree of competition, a monopoly lies at the opposite end of the spectrum from perfect competition. In perfect competition, there are many small companies, none of which can control prices; they simply accept the market price determined by supply and demand. In a monopoly, however, there’s only one seller in the market. The market could be a geographical area, such as a city or a regional area, and doesn’t necessarily have to be an entire country.

There are few monopolies in Canada because the government limits them. Most fall into one of two categories—natural and legal. Natural monopolies include public utilities, such as electricity and gas suppliers. Such enterprises require huge investments, and it would be inefficient to duplicate the products that they provide. They inhibit competition, but they’re legal because they’re important to society. In exchange for the right to conduct business without competition, they’re regulated. For instance, they can’t charge whatever prices they want; they must adhere to government-controlled prices. As a rule, they’re required to serve all customers, even if doing so isn’t cost-efficient.

A legal monopoly arises when a company receives a patent giving it exclusive use of an invented product or process. Patents are issued for a limited time, generally twenty years.^[1] During this period, other companies can’t use the invented product or process without permission from the patent holder. Patents allow companies a certain period to recover the heavy costs of researching and developing products and technologies. A classic example of a company that enjoyed a patent-based legal monopoly is Polaroid, which for years held exclusive ownership of instant film technology.^[2] Polaroid priced the product high enough to recoup, over time, the high cost of bringing it to market. Without competition, it enjoyed a monopolistic position in regard to pricing.