Imperfect competition

Imperfect competition refers to market structures that fall between the extremes of perfect competition and monopoly, characterized by the presence of many firms that sell products that are not perfect substitutes.
Updated: Jun 18, 2024

3 key takeaways

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  • Imperfect competition encompasses various market structures such as monopolistic competition, oligopoly, and monopolies, where firms have some degree of market power.
  • Firms in imperfect competition often differentiate their products through branding, quality, or other features, leading to non-price competition.
  • Prices in imperfectly competitive markets are typically higher and output lower compared to perfectly competitive markets due to the market power of individual firms.

What is imperfect competition

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Imperfect competition describes a market situation where the assumptions of perfect competition are not met. In such markets, individual firms have some control over the prices of their products due to factors like product differentiation, limited number of firms, or barriers to entry. Unlike perfect competition, where products are homogeneous and firms are price takers, imperfect competition features a variety of products and significant market influence by individual firms.

Importance of imperfect competition

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Understanding imperfect competition is vital for several reasons:

  • Market Dynamics: It explains the behavior of firms in real-world markets, where perfect competition is rare.
  • Pricing Strategies: Helps firms develop pricing and marketing strategies based on their market power and product differentiation.
  • Regulatory Policies: Informs government policies aimed at promoting competition and curbing monopolistic practices.

How imperfect competition works

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Imperfect competition operates through several distinct mechanisms depending on the specific market structure:

  1. Monopolistic Competition: Many firms sell similar but not identical products, leading to competition based on product differentiation, advertising, and brand loyalty. Each firm has some price-setting power.
  2. Oligopoly: A few large firms dominate the market, and their decisions on pricing and output can significantly impact competitors. This often leads to strategic behavior such as collusion or price wars.
  3. Monopoly: A single firm controls the entire market, setting prices and output levels with significant market power due to lack of competition.

Example of imperfect competition

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Consider the smartphone market:

  • Scenario: Several companies, such as Apple, Samsung, and Huawei, dominate the market.
  • Outcome: These companies differentiate their products through features, design, and brand image, leading to varied prices and consumer loyalty. Each company has significant control over its pricing and marketing strategies, reflecting an oligopolistic market structure.

Real world application

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Imperfect competition is observed in many real-world markets:

  • Retail Industry: Supermarkets and department stores often operate in monopolistic competition, offering differentiated products and using advertising to attract customers.
  • Automobile Industry: A few large firms dominate the market, showcasing an oligopoly where companies compete on features, brand, and innovation.
  • Technology Sector: Companies like Google and Microsoft hold significant market power in their respective areas, reflecting characteristics of both oligopoly and monopoly in certain product lines.

Understanding imperfect competition provides insights into how firms can strategically operate in markets where they have some degree of pricing power and can influence consumer preferences through product differentiation and marketing.

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