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.
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.
Imperfect competition commonly exists when a market structure is in the form of monopolies, duopolies, oligopolies, or monopsony.
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 and Unilever 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 suppliers, but only a small number of them. 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. In a monopsony there is a single buyer, rather than a single supplier, and that buyer 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.
Advantages and Disadvantages of Imperfect Competition
From the point of view of the firms, the main advantages of imperfect competition are:
- Firms can charge a higher price for their goods, which increases profits.
- Barriers to entry keep rival businesses out and limit competition.
- Higher profits can fund research, new products and branding.
The drawbacks of imperfect competition include:
- Because firms can influence prices, governments often have to step in to regulate them.
- If prices are pushed up too far, customers may be driven away and the product may fail.
- With only a few sellers who know each other's products well, rivalry is intense, and firms may be tempted to agree on prices or divide the market between them.
- With little competition, a few firms gain great influence over the market and earn large profits at the buyers' expense.