In a monopolistically competitive market structure, excess profits are eliminated in the long run through imperfect emulation of successful production systems, product design, and marketing efforts by both established and new competitors. Excess profits are eliminated in a perfectly competitive industry through expansion by established firms and entry of new firms, both of whom offer identical products that are perfect substitutes. The Oligopoly market structure results in long-run oligopoly market equilibrium that is identical to a competitive market price or output solution. In markets where competing firms produce identical products, the Bertrand model and competing markets theory result in a long-run oligopoly market equilibrium price or output solution that is identical to that achieved in a competitive market. According to Bertrand, when products and production costs are identical all customers will purchase from the firm selling at the lowest possible price. For example, consider a duopoly where each firm has the same marginal costs of production. By slightly undercutting the price charged by a rival, the competing firm would capture the entire market. In response, the competing firm can be expected to slightly undercut the rival price, thus recapturing the entire market. Such a price war would only end when the price charged by each competitor converged on their identical marginal cost of production, PA = PB = MC, and economic profits of zero would result. While critics regard as implausible Bertrand’s prediction of competitive market equilibrium in oligopoly markets that offer homogenous products, competing markets theory provides some additional useful perspective. Oligopoly firms will sometimes behave much like perfectly competitive firms if potential market entrants pose a credible threat and entry costs are largely fungible rather than sunk. A monopoly is the market situation, where a single firm makes the entire industry. That single firm has a complete control over the goods produced by monopolist firm and has no close substitute in the market. A monopoly is usually depicted as having less than optimal outcomes. A firm in a pure monopoly market is at the opposite end of the spectrum compared to a firm a pure competition market structure. The firm in the monopoly market structure has a degree of economies of scale which enables it to benefit from long run average costs; hence the monopolist makes abnormal profits in the long run.
Imagine a firm with the same cost structure but in each of the four very distinct market structures: (1) Purely Competitive, (2) Monopolistically Competitive, (3) Oligopoly, and (4) Monopoly. Why and how would a firm behave in each of the four markets? A firm with the same cost structure in a purely competitive market structure may be small in size and earn zero economic profit in the long run which leads to questionable ability to finance substantial Research and Development programs. In a purely competitive market structure there is a large number of firms hence no one firm can influence the price. For example if the firm is producing widgets, the firm can sell as much widgets as it has the ability to produce at the going price, but if the firm just raises the price, even slightly, demand goes to zero. Monopolistically Competitive is a market structure quite similar to Competitive in that vigorous price competition among a large number of firms and individuals is present. The major difference between these two market structures is that, there is at least some degree of product differentiation present in monopolistically competitive markets. As a result, a firm has at least some discretion in setting prices. However, the presence of many close substitutes limits the price-setting ability of individual firms, and drives profits down to a normal rate of return in the long-run. As in the case of perfect competition, above normal profits are only possible in the short-run before rivals are able to take effective counter measures. Examples of monopolistically competitive market structures include a broad range of industries producing clothing, consumer financial services, professional services, restaurants etc. Oligopoly is a market structure where only a few large rivals are responsible for the bulk, if not all, industry output. As in the case of monopoly, high to very high barriers to entry are typical. Under oligopoly, the prices or output decisions of a firm are interrelated in the sense that direct reactions from leading rivals can be expected. As a result, the decision making of an individual firm is based, in part, on the likely response of competitors. This competition among the few involves a wide variety of price and nonprice methods of inter-firm rivalry, as determined by the institutional characteristics of a particular market setting. Although deficiency in the number of competitors gives rise to a potential for excess profits, above-normal rates of return are far from guaranteed. Competition among the few can sometimes be vigorous. Examples of the oligopoly market structure include such industries as: brokerage services, investment banking, bottled and canned soft drinks, long distance telephone service, pharmaceuticals etc. A monopoly market structure is very rare in the ideal world and is considered as one of the blemishes in the market system. However a firm in a monopoly can be the only firm in a particular industry, there may be no close substitutes for the goods that this firm produces, and it’s unlikely that that a competing firm will survive. A firm in a monopoly market needs to preserve that monopoly which requires keeping potential rivals out of the market. A firm can establish a monopoly for itself by the control of a scarce input or resource. Another behavior of a firm in a monopoly is a natural monopoly; this implies being in an industry in which the advantages of large scale production makes it possible for the firm to supply the entire market output. For example utilities like electricity and water are often natural monopolies.