Market Power Part 1: Perfect Competition and the Price-Taker Life

Market Power Part 1: Perfect Competition and the Price-Taker Life

Let’s kick off this Market Power series with a riddle:

If a company can’t set its own prices, looks just like every other company in the market, and can be replaced overnight… what is it?

Welcome to the world of perfect competition - where market power is so low, it might as well be underground.

What Is Market Power?

In economics, market power means a firm’s ability to influence the price of a good or service. If you can raise your price and customers still buy it, congrats - you’ve got power. If not, you’re a price taker, stuck playing by the market’s rules.

Market power is shaped by market structure, which depends on:

• How many firms are in the market

• How hard it is to enter the market

• Whether firms compete through price, advertising, or product features

Let’s dive into the first major market structure: perfect competition.

Perfect Competition: The Econ Utopia (That Doesn’t Really Exist)

Perfect competition is more a theoretical dream than real-life reality - but it’s useful for understanding how markets behave when no one has control.

Characteristics of Perfect Competition:

1. Many buyers and sellers - No single firm is big enough to move the needle.

2. Free entry and exit - If profits are good, new firms jump in. If not, they leave.

3. Homogeneous products - Everyone sells the exact same thing. No branding, no tricks.

Add to that perfect information and knowledge - where everyone knows all the prices and qualities - and you’ve got the perfect econ classroom example.

Firms here are price takers. They accept the market price or they’re out. It's like selling bottled water at a festival. If yours costs £5 and everyone else's is £1, you're not selling anything unless you’re Beyoncé’s personal hydration assistant.

Real-Life (Almost) Examples

While no market is truly perfectly competitive, a few come close:

• Agricultural products – like wheat or potatoes, where one farmer’s crop is nearly identical to another’s

• Foreign exchange markets – currency is currency; there's no "premium" US dollar

• Stock markets – companies can’t set the price of their shares; buyers and sellers do

But even these are only nearly perfect. In reality, differences creep in - quality, branding, marketing, location, and regulation.

Imperfect Competition: The Real World

Most markets are far from perfect. That’s where imperfect competition comes in - and it takes many forms.

Monopolistic Competition: The Everyday Market

Monopolistic competition is basically your local high street: loads of businesses, each slightly different.

Key Features:

• Many firms, but each has a tiny bit of market power

• Free entry, but with product differentiation

• Firms compete with branding, style, service, and vibes

Think: hair salons, coffee shops, shoe brands.

You can open a café tomorrow, but will anyone come if they can go to Pret a Manger or the local indie spot that does latte art on sourdough toast?

Oligopoly: The Big Players’ Club

Oligopolies are markets with just a few large firms, holding serious market power.

Characteristics:

• High barriers to entry (think capital costs, tech, or regulation)

• Interdependence – firms watch each other like hawks

• Non-price competition is the name of the game: advertising, loyalty schemes, innovation

Think: smartphone giants, supermarket chains, or the UK’s “Big Four” banks (HSBC, Barclays, NatWest Group, and Lloyds Banking Group).

Why don’t these firms compete much on price? Because price wars are painful. Instead, they focus on branding, upgrades, and special deals to win customers.

Rational Producers and Profit Maximisation

At the end of the day, all firms - regardless of market structure - are assumed to act rationally. That means trying to maximise profit (Total Revenue − Total Costs).

Even the humble strawberry farmer in perfect competition wants to squeeze every penny from their patch. They just don’t have the power to set prices. That’s the price-taker life.

What’s Next?

In Part 2, we’ll discover how firms make, lose, or just about survive on profit. Marginal cost, revenue, and the big moment when MC = MR - all in this IB HL Market Power post.