What this lesson teaches
I can explain how current and possible competition shapes a firm's decisions.
Syllabus 9570, 2.2.3(b). Firms' Decisions and Strategies: Firms consider the existing and potential levels of competition in the industry when making decisions and engaging in strategies
Make a guess
Singapore has hundreds of hair salons, each with its own style, and opening one is fairly easy. Which market structure is this?
- Perfect competition, because there are so many salons.
- Monopolistic competition.
- Oligopoly, because a few big chains are well known.
Show the answer
Monopolistic competition.
Many firms, slightly different products and easy entry are the marks of monopolistic competition. Each salon has a little power over its own price.
Market structures differ in the number of firms, how similar their products are and how hard it is to enter.
The syllabus expects you to know four market structures, described by three features: how many firms there are, how similar their products are, and how easy it is for new firms to enter.
Perfect competition: many small firms selling identical products, with free entry. Each firm is a price taker. Monopolistic competition: many firms selling slightly different products, with easy entry, like cafes and hair salons.
Oligopoly: a few large firms, with high barriers to entry. Each firm must watch its rivals' reactions, as Singapore's telcos do. Monopoly: one firm with very high barriers to entry.
Structure shapes behaviour. The fewer the rivals and the higher the barriers, the more market power a firm has to set its price above cost.
- Perfect competition
- Many firms, identical products, free entry.
- Monopolistic competition
- Many firms, differentiated products, easy entry.
- Oligopoly
- Few large firms, high barriers.
- Monopoly
- One firm, very high barriers.
| Structure | Firms | Product | Entry |
|---|---|---|---|
| Perfect competition | Very many | Identical | Free |
| Monopolistic competition | Many | Differentiated | Easy |
| Oligopoly | A few large | Similar or differentiated | Difficult |
| Monopoly | One | No close substitutes | Blocked |
Worked example: Cafes versus mobile networks
A town has many cafes with different menus and easy entry. Its mobile network market has three large providers, with costly infrastructure and licences.
- Cafes: many firms, differentiated products, easy entry: monopolistic competition.
- Mobile networks: a few large firms, high barriers: oligopoly.
- The cafes have little power to raise prices; the mobile providers watch each other closely before changing plans.
Watch out for this
A market with only three firms must have high prices.
Structure affects market power, but prices also depend on how fiercely the firms compete, the threat of entry and regulation.
Check your understanding
Many firms sell slightly different products, and new firms can enter easily. Which structure is this?
- Monopolistic competition.
- Perfect competition, because entry and exit are free.
- Oligopoly, because each firm's product is different.
Show the answer
Monopolistic competition.
Right. Many firms, differentiated products and easy entry.