Market structures (SACE Stage 2 Economics)

What this dot point is asking

You need to compare the main market structures, explain what distinguishes them, and assess their effects on price, output, efficiency and consumer welfare.

What defines a market structure

A market structure is described by four key features:

• Number and size of firms in the market.
• Barriers to entry - how easy it is for new firms to enter.
• Product differentiation - whether goods are identical or differentiated.
• Degree of price-making power - whether firms are price takers or price makers.

These features place a market somewhere on a spectrum from perfect competition to monopoly.

Perfect competition

Perfect competition is a theoretical benchmark with many small firms, an identical (homogeneous) product, no barriers to entry, and perfect information. No single firm can influence the market price, so each is a price taker. Firms can earn only normal profit in the long run, because any abnormal profit attracts new entrants who compete it away.

Monopolistic competition

Monopolistic competition has many firms selling differentiated products, such as cafes, hairdressers or clothing brands. Differentiation (through branding, quality or location) gives each firm a little pricing power, so the demand curve slopes downward. Barriers to entry are low, so long-run profits are competed away to normal profit, but the variety of products is a benefit to consumers.

Oligopoly

An oligopoly is dominated by a few large firms, such as supermarkets, banks or petrol retailers in Australia. High barriers to entry and interdependence are the key features - each firm must consider how rivals will react. This leads to non-price competition (advertising, loyalty programs) and sometimes price stickiness. Firms may collude (which is illegal in Australia) or engage in price wars.

Monopoly

A monopoly is a market with a single seller and no close substitutes, protected by high barriers to entry. The monopolist is a price maker and can restrict output to raise price above the competitive level, earning long-run abnormal profit. Examples include some utilities and patent-protected medicines.

Monopolies are often allocatively and productively inefficient because they produce less and charge more than a competitive market would. However, a natural monopoly (where one large firm can supply the whole market at lower cost than several smaller firms, such as water pipes or electricity transmission) can be efficient, which is why such industries are often regulated rather than broken up.

Comparing the structures

Why this matters

Understanding market structures explains why prices and choice differ across industries, and why governments regulate some markets. In Australia, the Australian Competition and Consumer Commission (ACCC) enforces competition law to prevent the abuse of market power, block anti-competitive mergers and stop collusion - all of which protect consumers from the costs of weak competition.