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 is one in which individual buyers and sellers can influence prices and production, there is no full disclosure of information about products and prices, and there are high barriers to entry or exit in the market. It's the opposite of a perfect market, which is characterized by perfect competition, market equilibrium, and an unlimited number of buyers and sellers.
Imperfect markets are found in the real world, and are used by businesses and other sellers to earn profits.
Understanding Imperfect Markets
All real-world markets are theoretically imperfect, and the study of real markets is always complicated by various imperfections. They include:
- Competition for market share.
- High barriers to entry and exit.
- Different products and services.
- Prices set by price makers rather than by supply and demand.
- Imperfect or incomplete information about products and prices.
- Small number of buyers and sellers.
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 and there is a limited velocity of reactions. Economists only use perfect competition models to think through the implications of economic activity.
The moniker imperfect market is somewhat misleading. Most people will assume an imperfect market is deeply flawed or undesirable, but this is not always the case. 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.
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.
[Important: Governments may also use taxation, quotas, licenses, and tariffs to help regulate so-called perfect markets.]
Other economists argue that government intervention may be necessary to correct imperfect markets, but not always. This is because governments are also imperfect, and government actors may not possess the right 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.
- Imperfect markets do not meet the rigorous standards of a hypothetical perfectly or purely competitive market.
- They are characterized with having competition for market share, high barriers to entry and exit, different products and services, and a small number of buyers and sellers.
- Perfect markets are theoretical and don't exist, while all real-world markets have some form of imperfection.
- Structures of an imperfect market include monopolies, oligopolies, monopolistic competition, monopsonies, and oligopsonies.
Structures of Imperfect Markets
When at least one condition of a perfect market is not met, it can lead to an imperfect market. Every industry has some form of imperfection. Imperfect competition can be found in the following structures:
Monopoly: This is a structure in which there is only one (dominant) seller. Products offered by this entity have no substitutes. These markets have high barriers to entry and a single seller who sets the prices on goods and services. Prices can change without notice to consumers.
Oligopoly: This structure has many buyers but few sellers. These few players in the market may bar others from entering. They may set prices together or, in the case of a cartel, only one takes the lead to determine the price for goods and services while the others follow.
Monopolistic Competition: Here, there are many sellers who offer similar products that can't be substituted. Businesses compete with one another and are price makers, but their individual decisions do not affect the other.
Monopsony and Oligopsony: These structures have many sellers, but few buyers. In both cases, the buyer is the one who manipulates market prices by playing firms against one another.
Imperfect Markets vs. Perfect Markets
No serious economist believes that a perfectly competitive market could ever arise, and very few consider such a market desirable. Perfect markets are characterized by having the following:
- An unlimited number of buyers and sellers.
- Identical or substitutable products.
- No barriers to entry or exit.
- Buyers have complete information on products and prices.
- Companies are price takers meaning have no power to set prices.
In reality, 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. A diversity of goods and tastes are preferred in an imperfect market.
Perfect markets, although impossible to achieve, are useful because they help us think through the logic of prices 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, therefore, only be theoretically assumed—it can never be dynamically reached.