What Is Imperfect Competition?
Imperfect competition is a type of market where companies have some control over prices. This is in contrast to perfect competition, where many sellers don’t influence prices. Common examples include monopolies and oligopolies. Imperfect competition is more common in the real world than perfect competition. This article explains the main ideas, examples, and history behind imperfect competition.
Key Takeaways
- Imperfect competition occurs when market conditions deviate from the ideal of perfect competition.
- In imperfect competition, companies set their own prices and face barriers to entry and exit.
- Real-world examples of imperfect competition include monopolies, oligopolies, and monopolistic competition.
- Perfect competition requires identical products and no influence on prices by individual companies.
- Despite its theoretical nature, perfect competition rarely exists in reality.
Key Characteristics of Imperfect Competition
Perfect competition assumes conditions in microeconomics that help clearly define consumer behavior, supply and demand, and market pricing. In welfare economics and applied economics for public policy, perfect competition is also sometimes utilized as a standard to measure the effectiveness and efficiency of real-world markets.
In a perfectly competitive environment, the following criteria must be met:
- Companies sell identical products with no product differentiation
- The market consists of a large enough number of buyers and sellers so that no company can influence the price it charges and consumers alone set the price they are willing to pay each company
- All market participants and potential participants have free and perfect information about past, present, and future conditions, preferences, and technologies
- All transactions can be carried out with zero costs
- Companies can enter or exit the market without incurring any costs
Few businesses operate under perfect competition, with exceptions like some vendors at flea markets.
Competition becomes imperfect when the above conditions aren’t met. Differentiation in imperfect competition allows some companies to gain an advantage and earn more profit.
Important
In imperfect competition, companies can make more profit compared to the break-even scenario of perfect competition.
In an imperfectly competitive environment, companies sell different products and services, set their own individual prices, fight for market share, and are often protected by barriers to entry and exit, making it harder for new companies to challenge them. Imperfect competition is common in market structures like monopolies, oligopolies, and monopsonies.
The Evolution of Imperfect Competition Models
The treatment of perfect competition models in economics, along with modern conceptions of monopoly, were founded by the French mathematician Augustin Cournot in his 1838 book, “Researches Into the Mathematical Principles of the Theory of Wealth.” His ideas were adopted and popularized by the Swiss economist Leon Walras, considered by many to be the founder of modern mathematical economics.
Prior to Walras and Cournot, mathematicians had a difficult time modeling economic relationships or creating reliable equations. This model simplified economic competition into a predictable and static state. This avoided many problems that exist in real markets, such as imperfect human knowledge, barriers to entry, and monopolies.
The mathematical approach gained widespread academic acceptance, particularly in England. Any deviation from the new model of perfect competition was considered a troublesome violation of the new economic understanding.
Fast Fact
Neoclassical microeconomists in the 19th and 20th centuries claimed to be able to demonstrate mathematically that perfectly competitive markets could maximize economic efficiency and social
welfare.
One Englishman in particular, William Stanley Jevons, took the ideas of perfect competition and argued that competition was most useful not only when free of price discrimination, but also when there is a small number of buyers or a large number of sellers in a given industry. Thanks to the influences of Jevons, the Cambridge tradition of economics adopted a whole new language for potential distortions in economic markets—some real and some only theoretical. Among these problems were oligopoly, monopolistic competition, monopsony, and oligopsony.
Challenges Within Imperfect Competition
The Cambridge school’s wholesale devotion to creating a static and mathematically calculable economic science had its drawbacks. Ironically, a perfectly competitive market would require the absence of active competition.
All sellers in a perfect market must sell exactly similar goods at identical prices to the exact same consumers, all of whom possess the same perfect knowledge. There is no room for advertising, product differentiation, innovation, or brand identification in perfect competition.
No real market can or could attain the characteristics of a perfectly competitive market. The pure competition model ignores many factors, including the limited deployment of physical capital and capital investment, entrepreneurial activity, and changes in the availability of scarce resources.
Some economists use more flexible theories, like Mises’ evenly rotating economy. The Cambridge tradition’s language still dominates economics, influencing most Economics 101 textbooks.
What Is an Example of a Business in Imperfect Competition?
There are a multitude of examples of businesses and markets that exhibit characteristics of imperfect competition.
For instance, consider the airline industry. In this sector, there are limited firms operating and high regulatory and financial barriers to entry. Airline ticket sellers also typically have a high degree of control over price-setting, with consumers primarily acting as price takers. In addition, buyers in particular may not have free and perfect information about past, present, and future conditions, preferences, and technologies. Because of these factors and more, the airline industry exemplifies imperfect competition.
What Is an Example of a Perfectly Competitive Market?
The farmer’s market was mentioned above as a potential example of a perfectly competitive market. This would be the case if a few conditions were met: The many stalls at the farmer’s market sold identical or nearly identical products, such as fresh produce; shoppers could set the prices they were willing to pay; all transactions could be made without additional fees; all parties had full information about prices and the utility of products sold; and new vendors could enter the market without any obstacle. In reality, most farmer’s markets don’t meet these conditions. A market may limit the number of participating vendors, for instance, or vendors may vary what products they offer. However, such markets can closely approximate perfect competition under specific circumstances.
Is a Monopoly Imperfect Competition?
A monopoly is a clear example of imperfect competition. Defined as a market dominated by one seller, monopolies allow firms to set any price they wish and yield high levels of profit. In monopolistic industries, buyers rarely have full information about market conditions. When transacting, they may be subject to a range of fees and costs. In addition, monopolies often feature high barriers to entry for prospective competitors.
The Bottom Line
Imperfect competition happens when a market doesn’t follow the rules of perfect competition. This means that companies can set their own prices and make their products different from companies. In these markets, businesses face barriers to entering or leaving and compete for customers, which can lead to higher profits. Types of imperfect competition include monopolies, oligopolies, monopolistic competition, monopsonies, and oligopsonies. Most real-world markets show imperfect competition, unlike the rare perfect competition model. This can cause inefficiencies, like limited access to information and companies acting as price makers.