Imperfect Market

What is an 'Imperfect Market'

An imperfect market refers to any economic market that does not meet the rigorous standards of a hypothetical perfectly (or "purely") competitive market, as established by Marshellian partial equilibrium models. An imperfect market arises whenever individual buyers and sellers can influence prices and production, or otherwise when perfect information is not known to all market actors.

BREAKING DOWN 'Imperfect Market'

All real-world markets are theoretically imperfect, and the study of real markets is always complicated by various imperfections. For example, traders in a financial market do not possess perfect or even identical knowledge about financial products. The traders and assets in a financial market are not perfectly homogeneous. New information is not instantaneously transmitted to all actors, and there does not exist an infinite velocity of reactions thereafter. Economists only use perfect competition models to think through the implications of economic activity.

The moniker "imperfect market" is somewhat misleading. Lay readers may mistakenly assume an imperfect market is deeply flawed or undesirable, but this is not necessarily true. The range of market imperfections is as wide as the range of all real-world markets; some are much more or much less efficient than others.

Perfect Markets Can Never Exist

No serious economists believe that a perfectly competitive market could ever arise, and very few consider such a market desirable. No market can ever have an unlimited number of buyers and sellers. Economic goods in every market are heterogeneous, not homogeneous, as long as more than one producer exists. Diversity of goods and diversity of tastes are preferable aspects of imperfect markets.

Perfect markets are useful to think through the logic of prices, incentives and economic incentives. It is a mistake, however, to try extrapolating the rules of perfect competition into a real-world scenario. Logical problems arise from the start, especially the fact that it is impossible for any purely competitive industry to conceivably attain a state of equilibrium from any other position. Perfect competition can only be theoretically assumed; it can never be dynamically reached.

Implications of Imperfect Markets

Not all market imperfections are harmless or natural. Situations can arise in which too few sellers control too much of a single market, or when prices fail to adequately adjust to material changes in market conditions. It is from these instances that the majority of economic debate originates.

Some economists argue that any deviation from perfect competition models justifies government intervention to promote increased efficiency in production or distribution. Such interventions may come in the form of monetary policy, fiscal policy or market regulation. One common example of such interventionism is anti-trust law, which is explicitly derived from perfect competition theory.

Other economists argue that government intervention might be necessary to correct imperfect markets, but not always. This is because governments are also imperfect, and government actors may not possess the correct incentives or information to interfere correctly. Finally, many economists argue government intervention is rarely, if ever, justified in markets. The Austrian and Chicago schools notably blame many market imperfections on erroneous government intervention.

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