Definition
Imperfect competition is a term in financial economics that refers to a competitive market situation where there are many sellers, but they are selling heterogeneous (non-identical) products. Unlike in perfect competition, firms in an imperfect competition structure have the power to influence prices and market shares. Examples of imperfect competition models include monopolistic competition, oligopoly, and monopoly.
Key Takeaways
- Imperfect competition describes a market structure where all participants do not have perfect knowledge, which prevents them from optimizing their decision-making process. In such markets, traders can affect prices and have market power.
- Types of imperfect competition include monopoly, oligopoly, and monopolistic competition. Each one has different features, depending on factors such as product differentiation, the number of suppliers, and barriers to entry and exit.
- Even though imperfect competition is not efficient from a welfare standpoint, it can lead to more variety and diversity in products and services and may lead to better product quality and innovation due to the presence of competition amongst suppliers to differentiate their products.
Importance
Imperfect competition is a significant concept in finance because it describes a competitive environment where some participants have an unequal advantage over others.
This situation is important to understand as it is the reality of most markets and industries in today’s world.
Unlike perfect competition where all companies sell identical goods and have equal access to resources, in imperfect competition, companies possess the ability to influence prices, barriers to entry exist, products are differentiated, and perfect information is not always available.
Understanding this term is crucial for the development of competitive strategies, market regulations, pricing policies, and it also provides valuable insights into how businesses operate in real-world scenarios.
This knowledge is vital for businesses, policymakers, and consumers for informed decision-making, equitable policies, and fair trade practices.
Explanation
Imperfect competition refers to a market structure where the assumptions of perfect competition, such as identical goods, large number of sellers, and free entry and exit, are violated. The purpose of understanding imperfect competition lies in characterizing how firms behave in market conditions that differ from the ideal scenarios.
In imperfectly competitive markets, many concepts prevalent in perfect competition, like profits being driven to zero due to fierce competition, do not hold. Imperfect competition can provide firms more control over market pricing, allowing them to achieve potentially higher profits.
Imperfect competition is used to model real-world scenarios where markets are seldom perfect. Economic models predicated on imperfect competition offer better understanding of pricing strategies, market concentration, and the role of product differentiation.
An excellent example of this is the smartphone industry, where just a handful of providers dominate the global market, leading to a scenario of imperfect competition. This model helps us understand how firms strategize in order to set prices and create product variations to strengthen their market position, sometimes charging far more than the cost of production to earn significant profits.
Examples of Imperfect Competition
Telecommunication Industry: This industry is an excellent example of imperfect competition in many countries. Granted, there are several different companies that provide similar services, but only a few hold the majority of the market. The most significant players, such as AT&T, Verizon, and T-Mobile in the United States, have vast control over pricing and product offerings, which gives them an upper hand and creates substantial barriers to entry for new competitors.
Pharmaceutical Companies: A brand-name drug company operates under imperfect competition because its product doesn’t have perfect substitutes. When it patents a new drug, it holds a monopoly on the production and distribution of that drug until the patent expires. During that time, it can set prices well above what it would in a perfectly competitive market.
Airline Industry: Major airlines like American Airlines, Delta Air Lines, and United Airlines exhibit an oligopoly market structure, a type of imperfect competition. Individual airlines have control over their pricing, and these prices can greatly vary from one airline to another. Each airline offers different levels of service and pricing structures, causing an imperfectly competitive marketplace. Also, the high initial investment in the form of aircraft and infrastructure poses a significant entry barrier for newcomers in the industry.
FAQs on Imperfect Competition
What is Imperfect Competition?
Imperfect competition refers to a competitive market situation where there are many sellers, but they are selling heterogeneous (dissimilar) goods as opposed to the perfect competition model, which assumes that sellers are selling identical goods.
What are some examples of Imperfect Competition?
Imperfect competition can be found in markets that have few sellers and products that aren’t standardized. A few examples include the markets for automobiles, cellphones, or cable television services.
What are the types of Imperfect Competition?
There are several types of imperfect competition, including Monopoly (single seller), Monopolistic Competition (many sellers with differentiated products), Oligopoly (few sellers with either identical or differentiated products), and Duopoly (two sellers).
How does Imperfect Competition affect the economy?
Imperfect competition can lead to market failure, higher prices and a lack of innovation. However, it can also allow for improved products and increased consumer choice. The effect on the economy generally depends on the specifics of the market structure.
What is the difference between Perfect Competition and Imperfect Competition?
Perfect and Imperfect competitions are economic models that differ in several key ways. In Perfect competition, there are infinitely many sellers selling exactly the same product. In contrast, in Imperfect competition, there are few sellers and they sell differentiated products.
Related Entrepreneurship Terms
- Monopolistic Competition
- Oligopoly
- Market Power
- Price Discrimination
- Product Differentiation
Sources for More Information
- Econlib: This is the homepage of the Library of Economics and Liberty, a reliable source for understanding various economic concepts including Imperfect Competition.
- Investopedia: A comprehensive site for all finance-related information. It breaks down complex concepts, terms, and theories in an easy-to-understand language.
- Britannica: An online encyclopedia that covers a wide range of topics including economics. It could help in understanding the nature of Imperfect Competition.
- Khan Academy: This is a non-profit educational organization that provides free video tutorials and interactive exercises. This platform covers a variety of subjects, including economics and finance.
