Imperfect Competition

Definition

Imperfect competition refers to a market structure where the assumptions of perfect competition are not met, leading to some degree of market power for firms. This can occur due to product differentiation, barriers to entry, or the existence of few sellers in the market. As a result, firms can influence prices and output levels rather than being price takers, which creates a unique set of challenges in decision-making.

5 Must Know Facts For Your Next Test

1. In imperfect competition, firms have some control over their prices because they sell differentiated products or have fewer competitors.
2. Market power can lead to higher prices and reduced output compared to perfectly competitive markets, affecting consumer welfare.
3. Firms in imperfect competition often engage in strategic behavior, such as advertising and promotions, to increase their market share.
4. Barriers to entry, like high startup costs or strong brand loyalty, can prevent new competitors from entering the market and challenge existing firms.
5. Cognitive limitations and decision biases can affect how firms perceive their competitive environment and make pricing or production decisions.

Review Questions

• How does imperfect competition differ from perfect competition in terms of price setting and firm behavior?
  • In imperfect competition, firms have some control over their pricing due to product differentiation and limited competition. Unlike perfect competition, where firms are price takers and must accept the market price, companies in imperfectly competitive markets can influence prices through strategic decisions. This leads to varied behaviors such as advertising and innovation aimed at attracting consumers, highlighting the significance of market power.
• Discuss how cognitive limitations and decision biases can impact firms operating in an imperfect competition scenario.
  • Cognitive limitations may lead firm managers to underestimate competitors' reactions or overestimate their own market power. Decision biases such as overconfidence can result in poor pricing strategies or misjudged consumer preferences. These cognitive factors can distort strategic choices, leading to less effective responses to market changes compared to rational expectations found in perfectly competitive environments.
• Evaluate the implications of imperfect competition on consumer welfare and market efficiency compared to perfect competition.
  • Imperfect competition often results in higher prices and lower quantities produced than would occur under perfect competition, which can negatively impact consumer welfare. Additionally, the presence of market power allows firms to engage in practices that reduce overall market efficiency, such as creating barriers to entry or failing to innovate. This analysis highlights the complexities of real-world markets where behavioral factors intertwine with economic structures, influencing outcomes for consumers and society as a whole.

Related terms

Monopoly: A market structure where a single seller dominates the market, having significant control over prices and supply.

Oligopoly: A market structure characterized by a small number of firms that are interdependent and may collude to influence prices.

Product Differentiation: The process of distinguishing a product from others in the market to make it more attractive to specific consumers.