Market Structure
HCI 2024 Prelims
A cup of coffee can be priced as low as $1 in a neighbourhood coffee stall or as much as $6 in a café like Starbucks. The growing demand for specialty coffee has prompted new cafés to enter the already crowded market despite rising labour costs.
a) Explain which market structure best fits the market for coffee in Singapore, and why a café charges higher price for coffee than a neighbourhood coffee stall. [10]
Introduction
The market for coffee in Singapore features a wide range of sellers, from $1 neighbourhood coffee stalls to premium cafés like Starbucks charging up to $6 per cup. Despite selling the same basic product—coffee—these sellers operate under very different cost structures and consumer perceptions. To understand this variation in pricing, it is necessary to examine the underlying market structure and the factors influencing pricing decisions. This essay will argue that the coffee market in Singapore best fits oligopolistic competition, and explain why cafés are able to charge higher prices compared to neighbourhood coffee stalls.
R1: The market for coffee best fits Oligopolistic competition
Number of Sellers: The market for coffee in Singapore best fits oligopolistic competition, which is characterised by the presence of a few dominant firms, differentiated products, high barriers to entry (BTE), imperfect information, and strategic interdependence. Major players such as Starbucks and Coffee Bean & Tea Leaf hold substantial market share, resulting in a high market concentration ratio (MCR). Although many independent cafés and coffee stalls operate, they individually possess low pricing power, while the dominant chains significantly influence market outcomes.
Nature of Product: Firms in this market offer differentiated products — while all sell coffee, they vary in taste, service, ambience, and branding. This allows each firm to face a downward-sloping demand curve, enabling them to set prices above marginal cost. Consumers may prefer a $6 Starbucks coffee not just for the product itself, but also for the perceived quality and café experience.
Barriers to Entry: There are significant barriers to entry in this market. These include actual BTE such as high start-up costs, licensing requirements from the Singapore Food Agency, and ongoing rental and labour expenses. More importantly, perceived BTE such as strong brand loyalty and established customer bases make it difficult for new entrants to attract market share, even if their product is similar.
Information: Finally, the market exhibits imperfect information, as consumers may not have full knowledge about quality or pricing across all sellers, and firms operate without full visibility into the strategies and cost structures of their competitors. These characteristics collectively indicate that the coffee market in Singapore operates under oligopolistic competition.
R2: Cafe charges higher price for coffee than a neighbourhood coffee stall due to the different demand experienced.
Cafes like Starbucks and Coffee Bean & Tea Leaf have a larger market share compared to smaller neighbourhood coffee. Hence, the price-setting abilities allow cafes to engage in product differentiation and building of brand loyalty using the supernormal profit earned. For example, a cafe like Starbucks offers drinks with additional options such as flavoured syrups or plant-based milk in a more comfortable, air-conditioned space compared to hawker stalls that only serves coffee with or without traditional milk. Consumers thereby see other coffee stalls are less of a substitute to cafe coffees, allowing cafes to have a higher and more price inelastic demand curve of (ARcafe) and MR curve(MRcafe ) compared to that of neighbourhood stalls of ARn and MRn. The profit maximising price and quantity of a cafe is thus at Pc, Qc where MRc = MC, while smaller neighbourhood coffee stalls profit maximising price and quantity is at Pn, Qn where MRn=MC. Thus, cafes charge higher prices for coffee.
OR
R2: Cafe charges higher price for coffee than a neighbourhood coffee stall due to the different cost experienced.
Cafes generally incur higher marginal and average costs (MC and AC) compared to neighbourhood coffee stalls. This is due to their use of premium coffee beans, higher-quality equipment, and additional operational expenses such as skilled baristas, rental costs in prime locations, and store ambience expenses. This means that they experience both higher variable and fixed costs. Thus, cafes' cost curves, at ACc and MCc, lie above those of the neighbourhood stall, ACn and MCn. The profit maximising price and quantity of a cafe is thus at PcQc where MR = MCc, while smaller neighbourhood coffee stalls profit maximising price and quantity is at Pn ,Qn where MR=MCn. Thus, cafes charge higher prices for coffee where Pc > Pn.
Conclusion
The market for coffee in Singapore best fits the characteristics of oligopolistic competition, given the presence of a few dominant firms, differentiated products, high barriers to entry, and imperfect information. Within this market, cafés are able to charge higher prices than neighbourhood coffee stalls due to either facing a more price inelastic demand curve from product differentiation and branding, or incurring higher costs from offering premium products and services. These factors together explain the wide variation in coffee prices across different sellers in Singapore’s coffee market.
