What Is Imperfect Competition?

Imperfect competition exists whenever a market, hypothetical or real, violates the abstract tenets of neoclassical pure or perfect competition. The contemporary theory of imperfect versus perfect competition stems from the Cambridge tradition of post-classical economic thought.

Key Takeaways

  • Imperfect competition refers to any economic market that does not meet the rigorous standards of a hypothetical perfectly or purely competitive market.
  • In this environment, companies sell different products and services, set their own individual prices, fight for market share and are often protected by barriers to entry and exit.
  • Imperfect competition is common and can be found in the following types of market structures: monopolies, oligopolies, monopolistic competition, monopsonies, and oligopsonies.
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Imperfect Competition

Understanding Imperfect Competition

A perfect market is a theoretical concept in microeconomics that is used as a standard to measure the effectiveness and efficiency of real-world markets. In a perfect competition environment, the following criteria must be met:

  • Companies sell identical products
  • They cannot influence how much they charge for these products
  • Market share has no bearing on prices
  • Everyone is privy to the same information
  • Firms can enter or exit the market without incurring any costs

It is immediately apparent that very few businesses in the real world operate this way, bar perhaps a few exceptions, such as vendors at a flea or farmer’s market. If and when the forces listed above are not met, competition is said to be imperfect—it is labeled this way because differentiation results in certain companies gaining an advantage over others, enabling them to generate higher profit than peers, sometimes at the expense of customers.

Important

Imperfect competition creates opportunities to generate more profit, unlike in a perfect competition environment, where businesses earn just enough to stay afloat.

In an imperfect competition environment, companies sell different products and services, set their own individual prices, fight for market share and are often protected by barriers to entry and exit, making it harder for new firms to challenge them. Imperfect competitive markets are widespread and can be found in the following types of market structures: monopolies, oligopolies, monopolistic competition, monopsonies, and oligopsonies.

History of Imperfect Competition

The treatment of perfect competition models in economics, along with modern conceptions of monopoly, were founded by the French mathematician Augustin Cournot in his 1838 "Researches Into the Mathematical Principles of the Theory of Wealth." His ideas were adopted and popularized by the Swiss economist Leon Walras, considered by many to be the founder of modern mathematical economics.

Prior to Walras and Cournot, mathematicians had a difficult time modeling economic relationships or creating reliable equations. The new perfect competition model simplified economic competition to a purely predictive and static state. This avoided many problems that exist in real markets, such as imperfect human knowledge, barriers to entry and monopolies.

The mathematical approach gained widespread academic acceptance, particularly in England. Any deviation from the new model of perfect competition was considered a troublesome violation of the new economic understanding.

One Englishman in particular, William Stanley Jevons, took the ideas of perfect competition and argued that competition was most useful not only when free of price discrimination, but also when there is a small number of buyers or a large number of sellers in a given industry. Thanks to the influences of Jevons, the Cambridge tradition of economics adopted a whole new language for potential distortions in economic markets—some real and some only theoretical. Among these problems were oligopoly, monopolistic competition, monopsony, and oligopsony.

Limitations of Imperfect Competition

The Cambridge school’s wholesale devotion to creating a static and mathematically calculable economic science had its drawbacks. Ironically, a perfectly competitive market would require the absence of competition.

All sellers in a perfect market must sell exactly similar goods at identical prices to the exact same consumers, all of whom possess the same perfect knowledge. There is no room for advertising, product differentiation, innovation, or brand identification in perfect competition.

No real market can or could attain the characteristics of a perfectly competitive market. The pure competition model ignores many factors, including the limited deployment of physical capital and capital investment, entrepreneurial activity, and changes in the availability of scarce resources. 

Other economists have adopted more flexible and less mathematically rigid theories of competition, such as the evenly rotating economy. However, the language created by the Cambridge tradition still predominates the discipline—even today, the basic graphs and equations shown in most Economics 101 textbooks hail from these mathematical derivations.