Perfect vs. Imperfect Competition: What's the Difference?

Perfect vs. Imperfect Competition: An Overview

Perfect competition is a concept in microeconomics that describes a market structure controlled entirely by market forces. If and when these forces are not met, the market is said to have imperfect competition.

While no market has clearly defined perfect competition, all real-world markets are classified as imperfect. That being said, a perfect market is used as a standard by which the effectiveness and efficiency of real-world markets can be measured.

Perfect Competition

Perfect competition is an abstract concept that occurs in economics textbooks, but not in the real world. That's because it's impossible to attain in real life.

Theoretically, resources would be divided among companies equally and fairly in a market with perfect competition, and no monopoly would exist. Each company would have the same industry knowledge and they would all sell the same products. There would be plenty of buyers and sellers in this market, and demand would help set prices evenly across the board.

In order for a market to have perfect competition, there must be:

  • Identical products sold by companies
  • An environment in which prices are determined by supply and demand, meaning companies cannot control the market prices of their products
  • Equal market share between companies
  • Complete information about prices and products available to all buyers
  • An industry with low or no barriers to entry or exit

The entry and exit in perfect market competition is not regulated, which means the government has no control over the players in any given industry.

When it comes to their bottom lines, companies typically make just enough profit to stay in business. No one business is more profitable than the next. That's because the dynamics in the market cause them to operate on an equal playing field, thereby canceling out any possible edge one may have over another.

Since perfect competition is merely a theoretical concept, it is difficult to find a real-world example. But there are instances in the market that may appear to have a perfectly competitive environment. A flea market or farmer's market are two examples. Consider the stalls of four crafters or farmers in the market who sell the same products. This market environment is characterized by a small number of buyers and sellers. There may be little to differentiate between the products each crafter or farmer sells, as well as their prices, which are typically set evenly among them.

Imperfect Competition

Imperfect competition occurs in a market when one of the conditions in a perfectly competitive market are left unmet. This type of market is very common. In fact, every industry has some type of imperfect competition. This includes a marketplace with different products and services, prices that are not set by supply and demand, competition for market share, buyers who may not have complete information about products and prices, and high barriers to entry and exit.

Imperfect competition can be found in the following types of market structures: monopolies, oligopolies, monopolistic competition, monopsonies, and oligopsonies.

In monopolies, there is only one (dominant) seller. That company offers a product to the market that has no substitute. Monopolies have high barriers to entry, a single seller which is a price maker. That means the firm sets the price at which its product will be sold regardless of supply or demand. Finally, the firm can change the price at any time, without notice to consumers.

In an oligopoly, there are many buyers but only a few sellers. Oil companies, grocery stores, cellphone companies, and tire manufacturers are examples of oligopolies. Because there are a few players controlling the market, they may bar others from entering the industry. The firms in this market structure set prices for products and services collectively or, in the case of a cartel, they may do so if one takes the lead.

Monopolistic competition occurs when there are many sellers who offer similar products that aren't necessarily substituted. Although the barriers to entry are fairly low and the companies in this structure are price makers, the overall business decisions of one company do not affect its competition. Examples include fast food restaurants like McDonald's and Burger King. Although they are in direct competition, they offer similar products that cannot be substituted—think Big Mac vs. Whopper.

Monopsonies and oligopsonies are counterpoints to monopolies and oligopolies. Instead of being made up of many buyers and few sellers, these unique markets have many sellers but few buyers. Many firms create products and services and attempt to sell them to a singular buyer—the U.S. military, which constitutes a monopsony. An example of an oligopsony is the tobacco industry. Almost all of the tobacco grown in the world is purchased by less than five companies, which use it to produce cigarettes and smokeless tobacco products. In a monopsony or an oligopsony, it is the buyer, not the seller, who can manipulate market prices by playing firms against one another.

Key Takeaways

  • The market structure is controlled entirely by market forces in perfect competition.
  • In perfect competition, identical products are sold, prices are set by supply and demand, market share is spread to all firms, buyers have complete information about products and prices, and there are low or no barriers to entry or exit.
  • In the real world, there is no perfect competition but markets are represented by imperfect competition.
  • Imperfect competition occurs when at least one condition of a perfect market is not met.
  • Examples of imperfect competition include, but aren't limited to, monopolies and oligopolies.