Imperfect Competition

An economic concept used to describe marketplace conditions that render a market less than perfectly competitive

What is Imperfect Competition?

Imperfect competition is an economic concept used to describe marketplace conditions that render a market less than perfectly competitive, creating market inefficiencies that result in losses of economic value.

In the real world, markets are nearly always in a condition of imperfect competition to some extent. However, the term is typically only used to describe markets where the level of competition among sellers is substantially below ideal conditions.

 

Imperfect Competition

 

A situation of imperfect competition exists whenever one of the fundamental characteristics of perfect competition is missing. When there is perfect competition in a market, prices are controlled primarily by the ordinary economic factors of supply and demand.

Notably, the stock market may be viewed as a continually imperfect market because not all investors have ready access to the same level of information regarding potential investments.

Imperfect competition commonly exists when a market structure is in the form of monopolies, duopolies, oligopolies, or monopsony (very rare).

 

Summary

  • Imperfect competition is an economic concept used to describe marketplace conditions that render a market less than perfectly competitive, creating market inefficiencies that result in economic losses.
  • Perfect competition is characterized by a marketplace with numerous suppliers of identical, or nearly identical, goods or services.
  • Imperfect market structures include monopolies, duopolies, oligopolies, and monopsonies.

 

Perfect Competition

To understand imperfect competition, which is basically defined as the absence of perfect competition, one must first understand what a perfect marketplace looks like. In a marketplace with perfect competition, suppliers are price takers rather than price makers. The necessary characteristics for a market condition of perfect competition are as follows:

  • Prices in the marketplace are essentially controlled by the basic economic forces of supply and demand. In particular, sellers do not have any significant ability to control the prices of their goods or services.
  • Many different companies sell identical, or nearly identical, products or services. It means that buyers have several choices when making purchases; having many suppliers of identical products is key to perfect competition. Imperfect competition often results from a marketplace where there are many sellers. Still, they are all selling unique goods or goods that are substantially dissimilar to any goods sold by their competitors.
  • Several companies have roughly equal market shares, which is another factor that prevents a single supplier from being able to control market prices.
  • Market information is readily available and transparent – buyers have easy access to complete information about the products or services they wish to purchase.
  • The industry that provides goods or services to the marketplace has relatively little or no barriers to entry for potential new suppliers. It helps to ensure that the market has many suppliers, thus making it more competitive.

 

Imperfect Competition Market Structures

Market structures that effectively render competition imperfect are most often characterized by a lack of competitive suppliers. Imperfect competition often exists as a result of extremely high barriers to entry for new suppliers. For example, the airline industry has high barriers to entry due to the extremely high cost of aircraft.

The most extreme condition of imperfect competition exists when the market for a particular good or service is a monopoly, one in which there is a sole supplier. A supplier that has a monopoly on the provision of a good or service essentially has complete control over prices.

Because it has no competition from other suppliers, the sole supplier can essentially set the price of its goods or services at any level it desires. Monopolies often charge prices that provide them with significantly higher profit margins than most companies operate with.

A duopoly is a market structure in which there are only two suppliers. Although duopolies are somewhat more competitive than monopolies, the level of competition is still far from perfect, as the two suppliers still have significant control of marketplace prices.

An example of a duopoly exists in the United Kingdom’s detergent market, where Procter & Gamble (NYSE: PG) and Unilever (NYSE: UL) are virtually the only suppliers. The two suppliers in a duopoly often collude in price setting.

Oligopolies are much more common than either monopolies or duopolies. In an oligopoly, there are several – but a small, limited number – of suppliers. The market for cell phone service in the United States is an example of an oligopoly, as it is essentially controlled by just a handful of suppliers. The small number of suppliers, which limits buying choices for consumers, provides the suppliers with substantial, although not complete, control over pricing.

A rare form of imperfect competition is a monopsony. A monopsony is a single buyer, rather than any supplier, who has great control over market prices. Government entities often enjoy a monopsony position.

For example, the central government in any country is usually the sole buyer of certain military equipment. There may be multiple manufacturers selling such goods, but all the sellers are basically at the mercy of whatever price the government is willing to pay for the goods.

 

Learn More

CFI offers the Certified Banking & Credit Analyst (CBCA)® certification program for those looking to take their careers to the next level. To keep learning and advance your career, the following resources will be helpful:

  • Bargaining Power of Suppliers
  • Equilibrium Quantity
  • Legal Monopoly
  • Oligopoly

Financial Analyst Certification

Become a certified Financial Modeling and Valuation Analyst (FMVA)® by completing CFI’s online financial modeling classes!