The imperfect competition is the situation of market failure in which, unlike the situation of perfect competition, the law of supply and demand is not freely used to determine prices, but in which there must be a balance in the prices determined.
In a situation of imperfect competition, the firms may have sufficient market power to affect the price of the market. The main consequences of such market power have a negative impact on consumer welfare and a loss of efficiency.
It should also be taken into account that under certain circumstances, the fact that firms compete in such environments does not necessarily imply a loss of consumer welfare. In some cases, perfect competition is caused by the pricing power of producers, such as in oligopolies and monopolies, while in others, perfect competition is a consequence of the pricing power of the demanders, as in oligopsonies and monopsonies. Monopolistic competition is the manufacture of differentiated products at different prices and this also goes against the homogeneity of the product. Publicity is also a source of perfect competition, because it distorts the homogeneity of the product of the different producers and alters the prestige and degree of knowledge that consumers have of the products in a way that benefits the producer.
In economic theory, perfect competition is a type of market structure showing some but not all features of competitive markets.
HistoryThe concept of Imperfect Competition was initially developed by a prestigious English economist, Roy Harrod. In 1933, Joan Robinson of Cambridge University in England and Edward Chamberlin of Harvard University in America, two distinguished economists, complemented this concept with essential contributions.
ConceptIn parallel with perfect competition, imperfect competition can be defined as a competitive market, in which there are cases with a certain number of sellers, however in this situation the goods sold are heterogeneous. For this reason, each seller will undertake any price they want, since there is no other product with the exact same features available on the market. Usually, the seller will take advantage of this price decision to raise it, in order to earn more surplus profits. The high profits will be appealing to new potential sellers who want to join the market. As opposite, sellers who are incurring losses, will leave the market. The entry and exit of the market may have or not associated costs, thus the difficulty level depends on each case of imperfect competition. In economic theory, Imperfect competition gather the type of markets that deviates from the ideal perfect competition and can also be considered as a reflection of the real-world competition.
According to economists Samuelson and Nordhaus, imperfect competition "refers to markets where there is no perfect competition, because at least one seller is large enough to influence the market price and therefore has a negative-slope demand curve". Both authors point out that "imperfect competition refers to any kind of imperfection: pure monopoly, oligopoly or monopolistic competition".
CharacteristicsThere are some characteristics that have to be taken into account when describing the environment of imperfect competition:
Heterogenous/ Differentiated productOne important characteristic is that each seller trades differentiated product, so they can be considered close substitutes of each other, but there aren’t two products with the same exact features. As a result, a buyer can have its own preferences within two similar products, due to quality differentiation, for example.
Price makersIn most cases of imperfect competition, such as a monopoly or monopolistic competitive market, the sellers have enough power to define and influence the charged price of the commodity.
Imperfect informationBuyers do not know the characteristics of all the products on sale, nor the different prices at which they are offered; consequently, they assume the existing variations.
Selling costsIn a market where products are differentiated from each other, but considered to be close substitutes, there is the need to have other prices besides the price of the commodity, in order to make one seller’s good more attractive than the other. This is achieved by advertisement, promotions, marketing, among others.
Barriers to entry and the amount of buyers/suppliers in the market varies according to each type of market structure it is being referred.
Types of market structuresImperfect competition comprises the following types of markets structures: monopolistic competition, monopolies, oligopolies, monopsonies and oligopsonies.
|Market Structure||Number of suppliers and degree of product differentiation||Degree of control over price||Example|
|Monopoly||One supplier, no substitute products||Complete||Monopoly of drinking water services|
|Oligopoly||Few suppliers with homogeneous or differentiated products||Some||Vehicle manufacturing or chemical manufacturing|
|Monopolistic competition||Many suppliers with differentiated products||Some||Fast food|
|Monopsony||Single applicant||Complete||Public work|
|Oligopsony||Few applicants||Some||Major distributors|
perfectly competitive firms, but society benefits from the product differentiation. As an example of monopolistic competition it can be considerate restaurant businesses or even hometown hairdressers.
In the monopoly the amount exchanged is less than in perfect competition and the price to be paid is higher: there is a loss of welfare for consumers. A monopoly firm produces less output, has higher costs, and sells its output for a higher price than it would if constrained by competition. These negative outcomes usually generate government regulation.
There are usually barriers to market entry: patents, market size, control of some raw material,...
There can also exist the case of natural monopoly, in which is cheaper for a single firm to provide all output instead of having plenty suppliers producing parts of it.
Examples of monopolies in the real world are public utilities in some specific cities, Andrew Carnegie’s Steel Company and natural gas supplier in particular towns.total output. As a consequence, any modification regarding the charged price or produced quantity made by one firm will affect the remaining companies, thus the overall market conditions – mutual interdependence. The product they sell may or may not be differentiated and there are barriers to entry: natural, cost, market size,... or dissuasive strategies.
If they collude, they form a cartel to reduce output and drive up profits the way a monopoly does. Moreover, another significant characteristic is the prevalent high expenditure on advertisement. Oil companies, grocery stores or even telecommunication companies are examples of oligopolies.
Even though this type of market structure can’t be found so easily in real world, some coal companies are considered to be monopsonies.
- Massimiliano Vatiero, "An Institutionalist Explanation of Market Dominances". World Competition. Law and Economics Review, 32:221-6.