Economic theory of the firm recognizes four main types of market structure. Firms may experience a monopoly, oligopoly, monopolistic competition or perfect competition. The structural type determines the firm's behavior within the competitive market. Competition also determines overall firm profit expectations.
In a monopoly, one firm dominates the entire market. This firm has no competition and is therefore able to set prices at will. In most instances, legislation in capitalistic societies prevents monopolistic firms in a marketplace. The market power of a monopoly is considered harmful to consumers. However, government allows a few monopolies. Utility companies are an example of a government-permitted monopoly.
An oligopoly exists where only a few firms control the market. The firms are all able to earn abnormal profits due to high market pricing. There is little downward pricing pressure because all firms tend to keep prices high. These pricing practices may be either implicitly or explicitly collusive. In addition, high fixed costs pose a barrier to the entry of new firms in the market. The airline industry is an example of an oligopoly.
Markets with monopolistic competition have many firms and many products and few barriers to entry into these markets. Firms make production decisions and set prices based on their individual costs. While consumers have many available choices of products and firms, it is still possible for a single firm to gain a large share of the market. In monopolistic competition, the key to market power is firm or product differentiation. Restaurants and clothing stores are examples of firms that operate in a monopolistic competition.
Markets with perfect competition are highly competitive because many firms are producing identical goods. This type of market has low barriers to entry for producing these commodity goods. As a result, firms in these markets are price takers -- they merely take the market price for their goods. Examples of products produced in perfectly competitive markets are oil, wheat, corn and coffee.