By Stephen Simpson
Within the study of macroeconomics, there are certain basic goals for economic systems. Generally speaking, desirable goals include economic growth, full employment, economic efficiency (achieving the maximum output for the available resources), price stability and balanced trade. Most economists would also include economic freedom (the right to freely choose to work, invest and consume according to one's inclinations) as a key goal and some would also point to an equitable distribution of income as a worthwhile goal.
When considering the concept of market efficiency, it is also important to note the existence of those who basically oppose the notion that free markets are the desirable mechanism for allocating resources. In particular, egalitarianism holds that every participant in an economy should get an equal share, untying compensation from productivity.
While egalitarianism may be an extreme means of dealing with inequalities economies, these inequalities are important. Inequalities can arise from differences in abilities, differences in human capital, discrimination, individual preferences, market power and simple luck. Generally speaking, even the staunchest laissez faire economists oppose discrimination as it interferes with the efficient operation of the economy.
The Gini ratio is one commonly-used metric for economic inequality; in particular it measures the inequality of income distribution across an economy. (For more, see The Gini Index: Measuring Income Distribution.)
While there is still some academic interest in command and communist economics, and a fairly thriving interest in mixed economies (where there is a mix of government planning and market economics), most economic theory focuses on market systems. Market systems feature private property and economic participants are motivated by self-interest to maximize their happiness and profits.
Perfect competition is a market in which there are many small independent consumers and producers. Firms produce standardized products and there are no barriers to entry or exit. Firms competing in perfect competition are price-takers. By and large, perfect competition is a thought object (having no barriers to entry or exit is rare), but the market for freelance writing comes close. (For more, see Perfectly Competitive Markets.)
In a monopoly, there is a single producer and there are no close substitutes to that product. In a monopoly there are extremely high barriers to entry (if not outright prohibition of competition) and firms are price-setters without government intervention.
As most readers will realize, true perfect competition and true monopoly are quite rare in actual practice. More common, though, are monopolistic competition and oligopolies.
Monopolistic competition features a relatively large number of firms offering differentiated products. Barriers to market entry and exit are relatively low. Oligopoly sees a few large producers competing in a market, with either differentiated or standardized products. There are relatively significant barriers to entry, and some mutual interdependence among the producers. (For related reading, see Economic Basics: Monopolies, Oligopolies, and Perfect Competition.)
InsightsPerfect competition is an economic idea that does not exist in the real world but can be used as a standard to measure the efficiency and effectiveness of real world markets.
InsightsMonopolistic competition exists in industries that have many firms offering similar products or services: for example, restaurants, supermarkets and clothing stores.
InsightsWithout competition, monopolies can raise prices and lower quality leaving consumers little choice. But monopolies can benefit consumers as well.
InsightsA country with $100 billion in assets and four residents sounds good - unless three of them have $0.
InvestingA barrier to entry is any obstacle that restricts or impedes a company’s efforts to enter an industry.
InsightsThe Gini Index measures income distribution among a country’s residents.
InsightsLearn how individual decision-making turns the gears of our economy.
InvestingLearn more about this method used in inequity valuation and corporate finance.