; Chapter 12:Market Structure
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Chapter 12:Market Structure


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									             Chapter 12:Market Structure

A. Definition of market
 A market exists whenever buyers and sellers come into contact to do business.
 It is not confined to any physical locations.
 It is any context in which transactions of goods and services take place.
 E.g. goods may be bought and sold by phone or mail.

B. Explain whether market exists in the following situations?
1. May buys two tickets of Leon’s concert through mail-order               Yes / No
2. John buys some soft drinks in a supermarket.                            Yes / No
3. Mary made a birthday card to Grace.                                     Yes / No
4.   Patrick telephones his broker to buy some shares of HSBC              Yes / No
5.   Ann donates two packs of toys to those poor children.                 Yes / No

C. Two main types of market
  Product market:a market within which goods and services are transacted.
  Factor market:a market within which factor services are transacted. E.g.
      labour market.

D. Competition and market structure
 Sellers compete among themselves for the buyers’ expenditure. This kind of
     competition may occur in the following TWO forms:
      1. Price competition(價格競爭)         :sellers compete by setting the lowest price.
     2.                             :
                              (非價格競爭) sellers compete in areas like product
          Non-price competition
          quality, advertising, packaging and services other than price.

    Depending on their relationship in competition, sellers may engage in price or
     non-price competition.
                                                                               (市場
     The relationship among sellers in competition is called the market structure
     結構)of the sellers.

    E. A Concept Tour on the Market Structure

                                 Market structure

       Perfect competition                              Imperfect competition

                                          Monopoly        Oligopoly         Monopolistic

   There are TWO types of market structure:perfect competition(完全競爭)and
    imperfect competition (不完全競爭) .
   Imperfect competition can be subdivided into Monopoly (壟斷),Oligopoly
    (寡頭壟斷)and monopolistic competition (壟斷性競爭).

F. A market structure is identified according to the following features:
1. The number of sellers and buyers.
2. The nature of products, i.e. whether they are homogeneous ( 同 質 ) or
3. The ease of entry and exit.
4. The availability of information.
 These criteria are essential in determining the market structure of a particular

Perfect Competition

【1】Large number of buyers and sellers
       There must be a very large number of sellers and buyers in the market.
       Implication: the action of an individual seller or buyer is not able to
        influence the market price.

【2】Homogeneous Product(同質產品)
       The products of all sellers in the market must be identical in the eyes of
       Implication: as consumers have no preference for any particular seller’s
        good, no seller can persuade the consumers that their products are superior
        to that of others.

【3】Free Entry and Exit
       New sellers may enter and existing sellers may leave the market without any
        restriction, e.g. franchise, license, trade union etc.

       The entry and exit are totally free.

【4】Perfect Market Information
       Market information such as product design, quality, features, price, etc.,
        should be readily available to buyers and sellers.
       As for the buyers, they know where the product can be bought and the price
        charged by different sellers.

       As for the sellers, they know how the product is produced and the price at
        which it is sold.
       Implication:this condition ensures that no supplier has an advantage in
        producing a product and that nobody can successfully charge a higher price
        as buyers will immediately know about it and shift to other sellers.

Market Behaviour of a Firm under Perfect Competition
【1】Price-taking Behaviour
           As the supply of an individual seller is very small compared to that of the
            whole market, any increase or decrease in individual supply will not affect
            the market price and thus they can only take the market price.

           An individual seller will not charge a price higher than that of the others. It
            is because the information of the market is perfect and products are
            homogeneous. If the seller raise the price, buyers will instantly shift to other

           An individual seller will not lower the price. It is because due to keen
            competition, the prevailing market price has been set as low as possible. If
            any seller lowers the price, he will suffer loss.

 Thus, sellers under perfect competition are price-takers. They simply take the
  market equilibrium price.

【2】No Product Differentiation
             As the products are homogeneous and information is perfect, no seller
              can tell consumers that his product is superior to other sellers. Therefore,
              no individual seller engages in non-price competition such as advertising
              and package design.

             There is only price competition in this market.

Application:Is the stock market perfectly competitive?

 It is a perfectly competitive market It isn’t a perfectly competitive market
 There are a large number of buyers  Some big investors, such as fund
   and sellers in the stock market.      managers, can influence the prices of
                                         certain shares through their buying and
 Shares of the same company are
                                         selling decisions.
    It is easy to enter or exit the stock         Stock analysts, company directors and
                                                   institutional investors have access to
    market. E.g. by ringing up a broker,
                                                   more information about the company
    one can buy or sell shares.
                                                   than individual investors. Hence,
   Investors can get information about            information is not equally distributed
    the stock from its annual reports,             in the stock market.
    newspapers, magazines, brokers or

Imperfect Competition
1. Monopoly
Definition:A monopoly exists when there is only one seller of a product that has no
close substitutes.

The features of a monopoly:
【1】       No. of sellers
          There is only one seller in the whole industry.

【2】       Nature of products
          The product has no close substitutes.
                  Implication:As there is no close substitute for his product, a monopolist
                  can decide the market price of his product. For this reason, monopolists
                  are called price-makers or price-searchers.

                 The product can be homogeneous. For example, the electricity provided
                  by the China Light & Power Co Ltd is the same for all consumers.

                 A monopolist may also sell heterogeneous goods or services. For
                  example, the China Motor Bus Co Ltd uses both air-conditioned buses
                  and regular buses for the same route. Obviously, the services provided by
                  different types of buses are different, i.e. it provides heterogeneous

【3】     Ease of entry
       The entry of firms into the market is forbidden, i.e. entry barriers may be
        created by government franchise, huge capital investment, law and

【4】          The availability of information
            The market information is highly restricted. Accessing the information of
             the products produced by a monopolist is very difficult. This helps the seller
             to maintain its monopoly power in two ways:

             1.     If other sellers cannot get the information on producing the product, it
                    implies there are entry barriers.

             2.     If buyers cannot obtain information easily, they may not know that
                    there are substitutes for the product offered by the monopoly.

     Hence, the monopolist can remain as the only seller in the market.
Does a monopolist face any competition?
Discussion:Some people may think that a monopolist does not face any competition
because he is the only seller. Do you agree?(Take the MTRC as an example to think
of it)

Suggested Answer:

Let us take the Mass Transit Railway Corporation (MTRC)for example. Although
the MTRC does not face competition from a second producer of underground railway
services, it still faces competition form :

【1】Competition with substitutes - passengers may take other means of transport,
the MTRC has to compete with buses or minibuses.

【2】Competition for factors of production - the MTRC needs to hire drivers,
conductors and other personnel in providing its services. It needs to compete with
other firms for the needed factors of production.

【3】Competition from potential competitors – A new firm might develop a better
or an alternative product in the long term.

Market behaviour of monopolists

【1】   The monopolist is a price searcher
 A monopolist faces the entire market demand. If he lowers the price, he will sell
  more. If he raises the price, the quantity demanded will drop. Hence, he needs to
  search for or set a particular price that maximizes profits. Thus, a monopolist is a
  price searcher.

【2】    Non-price competition
 Although monopolists do not face direct competition, they still need to compete
  with sellers selling close substitutes. Non-price techniques like advertising and
  quality improvement are used.

How are monopolies formed?

Way              Explanation                                Examples
1. Government Government grants a firm the right to be         The Hong Kong
Franchise     the only supplier of a certain good or            Ferry (Holdings) of.
              service because governments want to               Ltd.
              prevent wasteful duplication and to avoid        The Kowloon Motor
              inefficiency.                                     Bus
                 However, firms operate under franchise
                                                               The Hong Kong
                 should pay royalties(專利稅)to the                Telephone Company
                 government and their prices and profits
                 are under the government’s regulation so
                 as to ensure that consumers are not
2. Government Government owns the industry and other           The Hong Kong Post
ownership     sellers are not allowed to enter the              Office
              industry.                                        The Water Authority
                                                               The Hong Kong
                                                                International Airport
3. Ownership     When a firm owns an important resource,       The Water Authority
of important     it becomes difficult for other firms to       De beers co. of South
resources        enter the industry.                            Africa owns a major
                                                                share of the world’s
                                                                diamond mines.
4.Natural  When the start-up capital required for an           The China Light and
  Monopoly industry is very large, it is difficult for a        Power Company Ltd
           new firm to enter the market. In order to 
(自然壟斷)                                                          The Hong Kong
           lower the average cost of production, a              Electric Co.
           new firm needs to produce a large output
           but the demand or the good may be                   The Hong Kong and
           limited. Thus, it is impossible for another          China Gas Company
           firm to enter the market.                            Ltd.
5. Copyright     Copyright laws give authors, publishers       The copyright of
and patent       and producers the right to monopolize          Jacky Cheung’s
                 their goods and services. Patent gives the     compact disc is
                 monopoly right of a good to its inventor.      owned by PolyGram
                                                                Records Ltd.
6. Integration   A monopoly can also be formed by
                 mergers and consolidations. Firms in the
                 same industry may combine together until
                 finally only one firm remains.

2. Oligopoly
Definition – An oligopoly exists when the market is dominated by several sellers.
Duopoly(雙頭壟斷)- is used to describe a market structure with only two sellers.

The features of an oligopoly:

【1】        No. of sellers

           There are a few dominant sellers supplying most of the output of a
            particular good in the market.

           For example, in petroleum trade, Shell, Caltex, Mobil and Essex are
            dominant sellers in the market. They contribute a large proportion of
            petrol traded in Hong Kong.

           Another example is the banking industry. In 1996, there were 182
            licensed banks (持牌銀行)in Hong Kong, but the banking industry is
            dominated by only a few large bank groups.

【2】Nature of products
           The sellers sell similar but differentiated goods.
            The products they sold are close substitute of each other, but they are
            differentiated in the eyes of consumers (although they may be exactly the
            same). For example, in petroleum trade, consumers may regard the petrol
            sold by Shell and Essex as similar but differentiated products.

【3】        Ease of entry
           The entry of new firms into the market is restricted. Some reasons are:

             1.   The existing firms are well established. They enjoy the benefits of
                  economies of scale. The new firms, as beginners, will have to pay a
                  large cost when competing with the existing firms.

             2.   The existing firms have already built up their brand names and
                  gained customers’ goodwill
                                          (商譽) New firms will have to advertise
                  heavily to compete with the existing firms.

             3.   The government may set up strict rules to govern entry, e.g strict
                  licensing requirement.

【4】    The availability of information.
       The information of the market is imperfect, i.e. information is obtained
        with cost. This enhances the ability of the dominant sellers to maintain
        their market power by:

      1.      Telling consumers that the products they sold are different form that of
            other sellers.

      2.      Preventing other potential entrants from getting information on the
            business and entering the market.

Market Behaviour of Oligopolists
【1】     Interdependence among sellers
      Under oligopoly, as there are only a few dominant sellers selling similar
          products, the sellers will observe the action of other sellers and act

           For example, a company will follow others to reduce the price of the
            products, otherwise it will lose some of its market share to its competitors.
            A price war will therefore be induced, some sellers may go out of

【2】        Price rigidity(價格僵性)
            As price war may result in mutual loss to the sellers, the sellers seldom
            change the price of the products. Hence, price of products sold by
            oligopolists tends to be rigid.
            For example, the price of petrol seldom changes. However, the
            companies often announce price change almost at the same time, which
            indicates interdependence among sellers.

【3】    Price leadership
       In some oligopolistic markets, the dominant sellers may act as leaders in
        initiating changes in prices. The smaller firms will then follow.

【4】        Non-price competition(非價格競爭)
           Oligopolistic sellers often engage in non-price competition to promote
            their products.
           For example, some petrol stations offer free drinks and gifts to
            customers;some credit card companies organize lucky draws to attract
            new card members.

3. Monopolistic competition
Definition:A market in which there are many firms selling a differentiated product.

The features of monopolistic competition
【1】      Number of sellers
        There are many sellers in the market. The competition among sellers is

【2】     Nature of the product
        The products are similar but differentiated(heterogeneous).
          Products are differentiated by their brand names, qualities, packaging or
            Reasons for products’ differentiation:
            1.   If a firm can make its product different or seem different, then it can
                 become the only supplier of that product and have some control over
                 the price of the product.

            2.   Buyers will probably be willing to pay extra for a good or service
                 which is or at least seems different form others.

             -   e.g. consumers may willing to pay a higher price for a walkman
                 bought from a shop with good reputation. It is because they may fear
                 hat a walkman bought from the shop with no reputation is a fake or
                 it may have no guarantee.

【3】     Ease of entry
        There are freedom of entry and exit unlike monopoly or oligopoly)
                                           (                              .New
           firms can compete with existing firms for business.

【4】     Availability of information
        The information is imperfect but easily available. Neither sellers nor
         buyers are fully aware of the price, quality and marketing techniques of
         other sellers.

          Sellers have to advertise in order to provide more information to
           consumers and thus increase their market share.

          Price and quality of goods sold by different shops can be known with a
           relatively lower cost.

Market Behaviour of a Firm under Monopolistic Competition.

【1】     Product Differentiation / non-price competition
        Advertising, sales services offering gifts and organizing lucky draws are
         examples of non-price competition.

【2】        Price-Searching (尋價)Behaviour
           As monopolistically competitive firms sell differentiated products, they
            can set a slightly higher price without losing all their customers.

           They need to find the particular price that maximizes profits. In other
            words, they are price searchers.

Essential features and behaviour of the firms under imperfect competition are
summarized in the following table:

Features                  Monopoly             Oligopoly            Monopolistic
Number of sellers         One                  A few dominant       Many
Nature of goods           Homogeneous or       Similar but          Similar but
                          heterogeneous        differentiated       differentiated
Ease of entry             Restricted           Restricted           Free
Market Information        Imperfect            Imperfect            imperfect
Pricing Behaviour         Price searcher       Price searcher       Price searcher
Non-price competition     Yes                  Yes                  Yes

 Imperfect competition is characterized by imperfect information.

 As information is costly to obtain, this implies non-price competition. Sellers
  may take advantage of imperfect information and persuade consumers that their
  products are superior to others by means of advertising, packaging, better
  services, quality etc.

 Sellers under imperfect competition are price-searcher. Each of them has some
  market power to control the price. However, they cannot set a very high price
    because a very high price will result in a very low quantity demanded. Therefore,
    they have to search for a suitable price for their product.

   Therefore, the stock market comes very close to, but not exactly is, perfect

   No market in the real world can be classified as perfect competition because
    information cannot be perfect, we have to pay a cost to obtain it.

   Other closed examples: gold market, vegetables retailing market.

           A summary of the different types of market structure

Features               Monopoly               Oligopoly        Monopolistic         Perfect
                                                               Competition          Competition
Number of buyers       Many       Many                         Many                 Many
Number of sellers      One        A few dominant               Many                 Many
Nature of goods    Homogeneous or Similar but                  Similar but          Homogeneous
                   heterogeneous  differentiated               differentiated
Ease of entry      Restricted /   Restricted                   Free / easy to       Free
                   forbidden                                   enter
Market Information Imperfect /    Imperfect /                  Imperfect / easy     Perfect
                   restricted     restricted                   to obtain
Pricing Behaviour Price searcher  Price searcher               Price searcher       Price taker
Non-price          Yes            Yes                          Yes                  No
competition (Y/N?)

Discussion Question:Identify the market structure of fast-food industry and give
reasons to support your answer. (9 marks)

Suggested Answer:There are two possible answers for this question.
               Answer 1                        Answer 2                             Marks
Identification The fast-food industry          The fast-food industry belongs to    1
               belongs to oligopoly.           monopolistic competition.
Reason 1       There are a few dominant        There are many sellers in the        2
               sellers in the market. E.g.     market. E.g. a lot of small
               McDonald’s, Hardees etc         fast-food shops.
Reason 2       The fast-food offered by        The fast-food offered by different   2
               different fast-food shops       fast-food shops are heterogeneous.
               are heterogeneous
Reason 3       It is difficult to enter the  It is easy to enter the market     2
               market to be a dominant       because the set-up cost is low and
               seller.                       it is rather easy to obtain a food
Reason 4        The information about the The information about the price of 2
                quality of product is rather product is rather easy to obtain.
                difficult to obtain.

 You may find that some markets are difficult to be classified into a particular type
  because they fall between oligopoly and monopolistic competition. It is quite
  usual in the reality as the features of a market are not so distinctive. Therefore,
  feel free to classify the market into either oligopoly or monopolistic competition.
  Your answer will be accepted if they are reasoned logically.

Suggest Approach:

                             Examine the nature of the product
                             in question.
                             e.g. fast-food - heterogeneous
                                            - product for retail

                         How many sellers are there in the market?

     One            Few dominant                 Moderate                     Many

                                       Feel free to choose either one

 Monopoly             Oligopoly                                         Monopolistic Competition

             Use the criteria 【ease of entry】&【the availability of
             information】to confirm the market structure.
                Oligopoly: difficult to enter the market + difficult ot
                 obtain market information.
                Monopolistic competition: easy to enter the market +
                 easy to obtain market information.


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