Key Takeaways
- Firms act as price makers, not price takers.
- Barriers to entry limit new competitors.
- Product differentiation enables non-price competition.
- Few dominant firms control market supply.
What is Imperfect Competition?
Imperfect competition describes market structures where sellers do not compete on equal terms, often due to product differentiation, market power, or entry barriers. Unlike perfect competition, firms under imperfect competition act as price makers rather than price takers, influencing prices above marginal cost.
This concept relates closely to oligopoly markets where few firms dominate and strategic interactions shape pricing and output.
Key Characteristics
Imperfect competition features several distinct traits that differentiate it from ideal competitive markets:
- Price Makers: Firms influence prices rather than accepting market prices, often leading to P > MC and reduced allocative efficiency.
- Barriers to Entry: High startup costs or regulations prevent new competitors, limiting market contestability.
- Product Differentiation: Goods vary by quality, branding, or features, enabling non-price competition.
- Market Power: Firms control supply decisions, which can affect prices and innovation incentives.
- Information Asymmetry: Unequal knowledge between buyers and sellers impacts market outcomes.
How It Works
In imperfect competition, firms face downward-sloping demand curves, giving them the ability to set prices strategically. This contrasts with perfect competition where firms are price takers and produce where price equals marginal cost.
Strategic decision-making, often analyzed through game theory, becomes crucial as firms anticipate rivals' responses to pricing or output changes. Barriers to entry further entrench incumbent firms, sustaining their market power over time.
Examples and Use Cases
Real-world markets often exhibit imperfect competition, influencing how companies compete and innovate.
- Airlines: Delta operates in an oligopolistic market with high capital requirements and limited competitors, impacting fare pricing and service differentiation.
- Technology: Apple leverages product differentiation and brand loyalty to maintain pricing power despite competition.
- Credit Cards: The market for travel rewards involves strategic competition, as seen in guides like best airline credit cards, where companies differentiate offerings to attract customers.
Important Considerations
Understanding imperfect competition helps you recognize why prices may be higher and output lower than in perfectly competitive markets. While this structure encourages innovation and variety, it may also lead to inefficiencies and requires regulatory oversight.
Factors such as the availability of factors of production and the price sensitivity of consumers, measured by price elasticity, influence how firms exploit their market power and how consumers respond.
Final Words
Imperfect competition allows firms to influence prices and create market inefficiencies due to barriers and product differences. To make informed financial decisions, compare market offers carefully and analyze pricing power within your industry.
Frequently Asked Questions
Imperfect competition describes market structures where sellers do not compete on equal terms, often due to barriers to entry, product differentiation, or market power. Unlike perfect competition, firms in imperfect competition act as price makers rather than price takers.
In perfect competition, many sellers offer identical products with no barriers, leading to prices equaling marginal cost. Imperfect competition violates these conditions, featuring fewer sellers, product differences, and barriers that allow firms to set prices above marginal cost.
The main types include monopoly, where a single firm dominates; oligopoly, where a few large firms control the market; and monopolistic competition, where many sellers offer differentiated products with some pricing power.
Firms have pricing power because they face downward-sloping demand curves and sell differentiated products or control supply. This lets them set prices above marginal cost, unlike in perfect competition where firms are price takers.
Barriers to entry like high startup costs or regulations prevent new competitors from entering the market easily. This helps existing firms maintain market power and influence prices.
Yes, because firms set prices above marginal cost, it can reduce efficiency and create deadweight loss. This often results in higher prices, lower output, and reduced consumer surplus compared to perfectly competitive markets.
Examples include utility companies operating as monopolies, the airline industry as an oligopoly, and restaurants or clothing brands competing under monopolistic competition with differentiated products.
