Market Structures: From Perfect to Imperfect Competition

Hey everyone! Ever wondered why there are so many different brands of shampoo but only one MTR system? Or why the price of a cabbage at one stall in the wet market is almost identical to the stall next to it? The answer lies in something economists call market structures.

In this chapter, we're going to explore the different "arenas" where firms compete. Understanding these will help you see the economic world around you with new eyes. It explains why some companies have huge power to set prices and others have none at all. Don't worry if it sounds complex; we'll break it down with simple explanations and real-life examples from Hong Kong!


First things first: What is a Market?

Before we dive into the different types, let's get one thing clear. A market isn't just a physical place like a supermarket. In economics, a market is any arrangement that allows buyers and sellers to interact and make transactions. This could be a physical location (like the Ladies' Market in Mong Kok), an online platform (like HKTVmall), or even the global stock market.


The Four Main Market Structures

We can classify markets into four main types based on their features. Think of it as a spectrum, from "maximum competition" to "no competition".

The key features we use to tell them apart are:

  • Number of sellers (Are there many, a few, or just one?)
  • Nature of the product (Are the products identical or different?)
  • Ease of entry (How easy is it for new firms to join the market?)
  • Availability of information (Do buyers and sellers know everything about the prices and products?)

Based on these, we get our four structures: Perfect Competition, Monopolistic Competition, Oligopoly, and Monopoly.



1. Perfect Competition: The Ideal (and Rarest) Market

Imagine a market that is as competitive as it can possibly get. That's perfect competition. It's a theoretical model, but it's super important because it gives us a baseline to compare other markets against.

Key Features:
  • Number of Sellers: There are a very large number of sellers, and each one is tiny compared to the whole market.
  • Nature of Product: All firms sell a homogeneous (identical) product. You can't tell the difference between one firm's product and another's. Think of a specific type of vegetable, like choi sum, from different farmers.
  • Ease of Entry: There are no barriers to entry or exit. Anyone can start or stop selling in this market freely.
  • Information: Information is perfect. All buyers and sellers know the prices and quality of the product everywhere.
Price Taker or Price Searcher?

In perfect competition, firms are price takers. This is a crucial concept! Because there are so many sellers with identical products, no single firm can influence the market price. If one farmer tries to sell their choi sum for $1 more than everyone else, who would buy from them? No one! They must "take" the price the market sets.

Real-world "Approximations":

Remember, perfect competition is a theoretical model. No real-world market is truly perfect. But some get close:

  • The market for a specific agricultural product, like a type of rice or vegetable.
  • The foreign exchange market, where currencies like the US dollar are traded.
Key Takeaway: Perfect Competition

Many sellers, identical products, free entry, perfect information. The result? Firms are price takers with no power over the market price. It's the ultimate form of competition.



2. Monopoly: The One and Only

Now let's jump to the complete opposite end of the spectrum. A monopoly is a market where there is only one seller. "Mono" means one!

Key Features:
  • Number of Sellers: There is only one seller. This single firm IS the entire industry.
  • Nature of Product: The product is unique with no close substitutes.
  • Ease of Entry: There are very high barriers to entry. It is extremely difficult or impossible for new firms to enter the market. (We'll look at why later!)
  • Information: Information may not be perfect, but it doesn't matter as much since there are no competitors to compare with.
Price Taker or Price Searcher?

A monopolist is a price searcher (or price setter). Because they are the only seller, they have significant power to choose the price they want to charge. They "search" for the price that will maximize their profit. Of course, they can't charge an infinite price—if the MTR charged $500 for a single trip, people would find other ways to travel! But they have a lot more control than a firm in perfect competition.

Real-world Examples in Hong Kong:
  • MTR Corporation: The sole operator of the mass transit railway system.
  • Hong Kong Electric Company: The sole provider of electricity to Hong Kong Island.
  • Towngas: The sole provider of gas to most households.
Key Takeaway: Monopoly

One seller, unique product, high barriers to entry. The result? The firm is a price searcher with significant market power.



3. Monopolistic Competition: The Realistic Mix

Okay, let's step back into a world that looks much more familiar. Monopolistic competition is a mix of monopoly and perfect competition. It's one of the most common market structures you'll encounter every day.

Key Features:
  • Number of Sellers: There are a large number of sellers, but not as many as in perfect competition.
  • Nature of Product: This is the key! Firms sell differentiated products. The products are similar but not identical. Firms compete using branding, quality, design, or location.
  • Ease of Entry: There are low barriers to entry. It's relatively easy for new firms to join the market.
  • Information: Information is imperfect. It takes effort to know all the prices and differences between products.
Price Taker or Price Searcher?

Firms in monopolistic competition are price searchers, but with limited power. Because their product is slightly different, they have some control over its price. For example, a popular cha chaan teng can charge slightly more for its milk tea than the one next door. However, this power is limited because if they raise the price too much, customers will just go to one of the many other competitors.

Real-world Examples in Hong Kong:
  • Restaurants and Cafes: Thousands of them, each offering a slightly different menu, price, or atmosphere.
  • Hair Salons: Many options, differing in style, price, and service.
  • Convenience Stores: 7-Eleven, Circle K, etc. They sell similar things but compete on location and specific promotions.
Did you know?

The main way these firms compete isn't on price, but through non-price competition. This includes advertising, branding (creating a cool image), packaging, and service quality. They are trying to convince you their product is special!

Key Takeaway: Monopolistic Competition

Many sellers, differentiated products, low barriers to entry. The result? Firms are price searchers with limited power, and they use non-price competition heavily.



4. Oligopoly: The Few Giants

An oligopoly is a market dominated by a few large firms. "Oligo" means a few. These giant firms are highly aware of each other's actions, and they are interdependent.

Key Features:
  • Number of Sellers: The market is dominated by a few large sellers.
  • Nature of Product: The products can be identical (like petrol) or differentiated (like smartphones).
  • Ease of Entry: There are high barriers to entry, making it difficult for new firms to challenge the giants.
  • Interdependence: This is the most important feature! The actions of one firm directly affect the others. Before making a decision on price or advertising, a firm must consider how its rivals will react. If ParknShop has a big sale, Wellcome will likely respond.
Price Taker or Price Searcher?

Firms in an oligopoly are price searchers. Their interdependence leads to a behaviour called price rigidity, meaning prices tend to be stable and don't change often. Firms are afraid to lower prices because it might start a "price war" where everyone loses profit. They are also afraid to raise prices because rivals might not follow, and they would lose customers.

Real-world Examples in Hong Kong:
  • Supermarkets: Dominated by ParknShop and Wellcome.
  • Mobile Network Providers: A few big players like CSL, 3, SmarTone, and China Mobile HK.
  • Bus Companies: KMB, Citybus, and New World First Bus control most routes.
Key Takeaway: Oligopoly

A few large sellers, high barriers to entry, interdependence. The result? Firms are price searchers, and prices are often rigid. They watch each other like hawks!



Quick Review: Summary of Market Structures

This table is your best friend for revision! Don't worry if you can't remember everything at once, just come back to this summary.

Feature
Perfect Competition
Monopolistic Competition
Oligopoly
Monopoly

No. of Sellers
Very Many
Many
A Few
One

Nature of Product
Homogeneous (Identical)
Differentiated
Identical or Differentiated
Unique

Barriers to Entry
None
Low
High
Very High

Firm's Power over Price
None (Price Taker)
Limited (Price Searcher)
Considerable (Price Searcher)
Significant (Price Searcher)

HK Example
(Approx.) Stock Market
Restaurants, Salons
Supermarkets, Mobile Networks
MTR, Towngas



Sources of Monopoly Power (or High Barriers to Entry)

You might be wondering, "Why is it so hard to enter some markets?" This is due to barriers to entry, which are the source of power for monopolies and oligopolies. The syllabus wants you to know a few key sources:

1. Natural Monopoly

Sometimes, it's most efficient for only one firm to serve the entire market. This usually happens when there are extremely high start-up costs (fixed costs). Imagine trying to build a second MTR system right next to the existing one. It would be incredibly expensive and wasteful! The huge cost means one company can supply the good at a lower average cost than two or more companies could.
Examples: Water supply, electricity grid, railway networks.

2. High Set-up Costs

This is related to natural monopoly but is a broader category. Some industries just require a massive initial investment in equipment and infrastructure that most new companies can't afford.
Example: Building a new supermarket chain to compete with ParknShop and Wellcome would require billions in investment for stores, warehouses, and logistics.

3. Legal Entrance Restrictions

Sometimes, the government grants a firm the exclusive right to produce a good or service. This creates a legal barrier to entry.

  • Patents and Copyrights: These protect inventions and creative works, giving the creator a temporary monopoly. (e.g., a pharmaceutical company with a patent on a new drug)
  • Licences and Franchises: The government may only issue a limited number of licences to operate in a market. (e.g., TV broadcasting licences)

4. Public Ownership

In some cases, the government itself owns and operates the monopoly. This is often done for services considered essential.
Example: The Hong Kong Post Office is a government-owned entity with a monopoly on certain mail services.

Key Takeaway: Sources of Monopoly Power

Monopolies and oligopolies exist because high barriers prevent competitors from entering the market. These barriers can be natural (cost advantages), financial (high set-up costs), or legal (government restrictions/ownership).