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Simple Guide to Perfect and Imperfect Competition

  • Akshit Anthony
  • Nov 27, 2021
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One of the most fundamental topics in economics is healthy behaviour in competitive marketplaces. Most marketplaces we encounter in the real world are competitive, at least to some extent.

 

Several enterprises selling the same (or a comparable) commodity or service or a close alternative characterises competition. In general, the more equivalent the goods or services are, the more competitive the market. 

 

However, a market's competitiveness is still heavily influenced by corporate behaviour. Companies engaged in a collusive activity obstruct competition significantly. For the time being, we'll presume that businesses don't engage in such actions.

 

As previously stated, competitive marketplaces can have varying degrees of competition. Competitiveness helps explain two types of market  structures: perfect and imperfect competition.

 

(Must read : Positive and Normative Economics - What is the difference? )

 

 

What is Perfect Competition?

 

 

Perfect competition, as the name implies, is the purest form of competition. The following characteristics must be satisfied for a market to be perfectly competitive:

 

  • The things that are sold must be uniform. In other words, they must be identical and so maybe swapped at no expense.

 

  • There can't be any preferences among the sellers. Customers should not be concerned about the merchant from which they get their goods.

 

  • No one should be able to influence the market price. That is to say, neither buyers or sellers have any market strength and are hence price takers.

 

When you look at these conditions, it's clear that they'll seldom be satisfied in practice. Even yet, one market that comes near to complete competition is the rice market. There are thousands of customers and vendors, and most of the items are the same. However, there will always be tiny disparities in items, seller preferences, so it will never be competitive.

 

However, it is vital to remember that the goal of perfect competition as a theoretical construct is to explain diverse market mechanisms and economic behaviour. 

 

So, even if we don't find completely competitive marketplaces in the actual world, the principle is still quite significant.

 

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Limitations of Perfect Competition

 

The optimal foundation for developing a market is created by perfect competition. However, that market is defective and has several drawbacks. The first is a lack of inventiveness. 

 

Firms are motivated to innovate and create better goods to get a larger market share and differentiate themselves from the competition. In an ideal match, however, no business has a dominant market share. 

 

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Demand and supply also influence profit margins. As a result, businesses cannot differentiate themselves by charging a higher price for their goods and services. For example, a company like Apple  would be unable to survive in a fully competitive market since its phones are more expensive than those of its competitors.

 

As we are talking about consumer demand, you can check out our blog to understand about the factors that affect price elasticity of demand. 

 

Another issue is the lack of scale economies. Companies will have less capital to develop their manufacturing capacity if profit margins are limited to zero. The consumer expenses are reduced, and company profit margins could be increased if manufacturing capacities are expanded. 

 

The presence of several small businesses that cannibalise the market for the same product on the other hand forbids this guaranteeing that the average firm size remains modest.

 

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Example of Perfect Competition

 

Consider a farmers market where all of the vendors offer the same jam. Because they all use the same recipe and sell them at the same price, their products have little diversity. 

 

Simultaneously, sellers are scarce and unrestricted in their participation in the market. The buyers get fully informed about the product's formula and any other essential information in this case.

 

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Imperfect Competition

 

Imperfect competition arises when a hypothetical or actual market fails the abstract concepts of perfect neoclassical competition. Companies in this economy sell various products and services, determine their prices, compete for market share, and are frequently protected by entry and exit barriers.

 

In reality, imperfect competition, as opposed to a perfect match, is a reasonably frequent market structure. The following qualities distinguish it:

 

  • Differentiated items are offered for sale. Even though they mostly meet the exact demands, subtle variances allow clients to recognise the things.

 

  • Customers acquire preferences for certain suppliers as a result of the distinct goods. As a result, they are prepared to spend more money on specific merchants' items.

 

  • As a result, the sellers may have some market power and charge a higher price. Also, they can have a limited direct impact on market pricing and are no longer pure price takers.

 

Although imperfect competition and monopolistic competition are frequently used interchangeably, they are not the same. Imperfect competition is a broad term that refers to any market arrangement between perfect competition and monopoly. 

 

As a result, monopolistic competition, like oligopolistic market systems, is a sort of imperfect competition.

 

With a few exceptions, such as sellers at a flea market or farmer's market, it's clear that very few enterprises in the actual world function this way. 

 

Competition is considered imperfect if and when the factors described above are not met—it is branded this way because differentiation allows specific organisations to gain an edge over others, allowing them to produce more profits than peers, often at the price of customers.

 

Enterprises provide various products and services, establish their pricing, compete for market dominance, and are typically protected by obstacles to entrance and departure, making it difficult for new companies to challenge them in an imperfectly competitive environment. 

 

Imperfect competitive markets are common and may be found in monopolies, oligopolies, monopolistic competition, monopsonies, and oligopsonies, among other market structures.

 

(Related blog - Classical vs neoclassical economics)

 

 

Limitations of Imperfect Competition

 

The Cambridge school's passionate pursuit of mathematically calculable and static economic science is not without drawbacks. Ironically, the absence of aggressive competition is required for a genuinely competitive market.

 

In a perfect market, all vendors must sell identical commodities at equal prices to the same buyers who have complete information. There is no place for advertising, product distinction, innovation, or brand identity in perfect competition.

 

A fully competitive market is something that no genuine need can or will ever achieve. The pure competition model ignores many aspects, including the local deployment of physical capital and capital investment, entrepreneurial activity, and changes in the availability of scarce resources.

 

Other economists have embraced less mathematically rigorous and more flexible theoretical frameworks, such as Mises' evenly rotating economy. 

 

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Example of Imperfect Competition

 

The cereal industry is a good illustration of imperfect competition. Consider your local supermarket's cereal aisle, where you'll discover hundreds of various cereals (Cap'n Crunch, Lucky Charms, Froot Loops, Apple Jacks). 

 

Like most individuals, you undoubtedly have a favourite brand among those listed. But, when you think about it, those cereals aren't that dissimilar. Finally, they all have the same purpose: to provide you with a delicious breakfast.

 

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Perfect Competition V/s Imperfect  Competition

 

 

The market structure has been divided into two primary groups: Perfectly competitive and Imperfectly competitive. Because it is built on many assumptions, perfect competition does not exist in the actual world market. 

 

However, an Imperfect Competition is linked to a pragmatic approach.

 

The market structure determines the market share of a company. If there is just one business, it will service the whole market, which will only meet clients' demands. However, if the number of enterprises is increased to two, the market will be shared by the two. Similarly, if there are around 100 small enterprises in the market, they are equally shared by all of them.

 

As a result, the market structure has an impact on the market. 

 

In the last section of the blog we will discuss the contrasts between perfect and imperfect competition.

 

Basis of distinction

 

Perfect Competition

Imperfect Competition

 

 

Meaning

 

Perfect competition is a competitive market in which many suppliers sell similar items or services to a large number of customers.

Imperfect competition is an economic framework that does not meet the ideal competition requirements.

 

Nature of concept

 

 

Theoretical

 

Practical

 

Product differentiation

 

 

None

 

Slight to Moderate

 

Players

 

 

Many

 

A few to a large number

 

Restricted entry

 

 

No

 

Yes

 

 Firms are

 

 

 Price takers.

 

 Price makers.

 

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Conclusion

 

A variety of enterprises selling the same (or comparable) item or service or near alternatives characterises a competitive market. They might be flawlessly competitive or shabbily competitive. 

 

The items are homogenous in fully competitive marketplaces. Customers have no preferences, and neither buyers or sellers may affect the market price. On the other hand, imperfectly competitive marketplaces have different products, customer preferences, and, as a result, a degree of market power for sellers.

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