Fritz Machlup, Monopoly and Competition: A Classification of Market Positions (1937)

Machlup’s theoretical article classifies selling-market positions through sellers’ expectations, the demand curves they perceive, and the conditions governing entry and adjustment. Its organizing distinction concerns whether a seller anticipates other sellers’ responses when considering changes in price or output.

The main division is that between sellers whose calculations or deliberations include expected reactions of rival sellers and, on the other side, sellers who do not engage in such complicated reflections.

This behavioral criterion places duopoly and oligopoly together as rival-conscious positions. Their sellers must estimate both buyers’ responses and competitors’ reactions. Product differentiation supplies a further distinction within this group, but does not define its strategic character. The significance of having few sellers lies in their perceived interdependence, rather than in numbers considered independently of conduct.

If the seller expects the reactions of his rivals to take place without any delay, then the estimate of these reactions often precedes the estimate of buyers' reactions.

Timing thus enters the classification through the seller’s deliberations. Expected immediate retaliation affects the alternatives he considers from the outset; delayed reactions can produce different short- and long-period assessments of demand. The relevant demand curve expresses the quantities the seller believes he can sell under these anticipated conditions.

Monopoly, monopolistic competition, and pure competition occupy the contrasting category, in which sellers do not calculate rivals’ reactions. This grouping follows consistently from Machlup’s criterion: a monopolist has no relevant rival, while a seller among very many competitors regards his individual action as too insignificant to provoke retaliation. Within the latter setting, homogeneous products imply infinitely elastic individual demand, whereas differentiation allows a seller to retain some customers after increasing price. Differentiated oligopoly remains separate because its sellers anticipate strategic responses.

Machlup next distinguishes the purity of competition from its perfection. Purity concerns product homogeneity and the elasticity of individual demand; perfection concerns adjustment and the elimination of abnormal returns.

Competition may be pure and perfect, pure and imperfect, monopolistic and perfect, monopolistic and imperfect; the first in each of these pairs of adjectives refers to the shape of the demand curve, the second to its position in relation to the cost curves.

The distinction prevents product differentiation from being equated with enduring excess profits. Pure competition can remain imperfect when transfer costs, frictions, and delays obstruct the equalization of returns, despite horizontal individual demand curves. Conversely, monopolistic competition can be perfect when free and easy entry removes supernormal profits despite downward-sloping demand. New sellers offering close substitutes move incumbents’ demand curves toward tangency with average cost. Imperfect monopolistic competition permits abnormal returns while entry and withdrawal remain incomplete.

The boundary between monopoly and imperfect monopolistic competition therefore depends on duration and the character of protection against entry. Their short-run positions may resemble each other, but delayed adjustment eventually erodes the monopolistic competitor’s advantage. Monopoly requires protection more enduring than ordinary friction, moving costs, or time-lags. Nevertheless, monopoly can itself be imperfect when government intervention or potential competition constrains pricing.

Machlup distinguishes the threat confronting an imperfect monopolist from the gradual entry affecting monopolistic competition. The imperfect monopolist anticipates a price threshold beyond which competitors may enter; the upper range of his perceived long-period demand curve consequently becomes markedly more elastic. This prospect can restrain his price. Under imperfect monopolistic competition, actual entry instead progressively shifts and reshapes the incumbent’s demand curve. Such change need not have been anticipated, and anticipating it may encourage exploitation of a temporary advantage rather than restraint.

The classification ultimately allows neighboring positions to overlap. A monopolistic competitor expecting eventual entry may reason much like an oligopolist anticipating delayed retaliation. Machlup’s contribution is therefore an analytical separation of strategic awareness, demand elasticity, and adjustment conditions, not a claim that every observed market fits an impermeable category. His framework also preserves the distinction between market changes sellers foresee and those they experience only as adjustment unfolds.