Imperfect competition

Definition

Imperfect competition refers to a market structure where firms have some control over the price of their goods or services, unlike in perfect competition where no single firm can influence the market price. This structure is characterized by the presence of product differentiation, a limited number of firms, and barriers to entry, allowing companies to maintain some level of pricing power and earn economic profits. This concept is crucial for understanding how firms operate within the framework of new trade theory, which emphasizes the role of economies of scale and network effects in international trade.

5 Must Know Facts For Your Next Test

1. Imperfect competition allows firms to set prices above marginal costs, which is not possible in perfect competition.
2. In markets characterized by imperfect competition, firms can engage in marketing strategies to differentiate their products and attract consumers.
3. Barriers to entry in imperfectly competitive markets prevent new firms from easily entering and competing, allowing existing firms to maintain their market power.
4. Imperfect competition can lead to allocative inefficiency, where resources are not distributed in a way that maximizes total welfare.
5. New trade theory highlights how imperfect competition can lead to increased international trade due to economies of scale, as larger firms can export their differentiated products more effectively.

Review Questions

• How does imperfect competition differ from perfect competition in terms of pricing and market power?
  • In imperfect competition, firms have some degree of control over the price of their goods or services because they produce differentiated products and face less intense competition than in perfect competition. In contrast, perfect competition features many firms selling identical products, meaning no single firm can influence the market price. This ability to set prices above marginal costs enables firms in imperfectly competitive markets to earn economic profits.
• Discuss the role of product differentiation in imperfect competition and its implications for international trade according to new trade theory.
  • Product differentiation in imperfect competition allows firms to create unique products that cater to specific consumer preferences, giving them the power to charge higher prices. This differentiation is crucial for international trade as it enables firms to compete globally by offering distinct products that appeal to various markets. New trade theory emphasizes how this strategy leads to economies of scale, where larger production volumes lower costs, encouraging more firms to enter international markets.
• Evaluate the impact of imperfect competition on economic welfare and resource allocation compared to perfect competition.
  • Imperfect competition can result in allocative inefficiency, as firms may restrict output and charge higher prices compared to perfect competition, where prices equal marginal costs. This inefficiency means that consumer surplus is reduced, as fewer units are sold at higher prices. Additionally, resources may not be allocated optimally since firms are not incentivized to produce at the lowest possible cost or meet all consumer demand, leading to potential deadweight loss in the economy.

Related terms

Monopolistic competition: A type of imperfect competition where many firms sell products that are similar but not identical, allowing for product differentiation and some degree of pricing power.

Oligopoly: A market structure characterized by a small number of large firms that dominate the market, leading to limited competition and the ability to influence prices.

Economies of scale: Cost advantages that firms experience as they increase production, leading to lower average costs and potentially higher profits in imperfectly competitive markets.