Understanding Perfect and Imperfect Competition
Perfect competition is a thought of microeconomics that looks at a market system where market forces have a monopolistic control. As long as these forces are met, the market is said to be in perfect competition. But, there has been no market that clearly defines ideal competition. In the real world, getting forces that work in perfect control is not possible; hence, all markets are classified as imperfect. A perfect market is simply a standard that measures how practical and real-world markets operate.
In microeconomics, the study of perfectly competitive and not perfectly competitive markets is paramount. The subject affects most of the aspects of a real market in the economy, including decision making, supply, demand, pricing, and many other variables as you may already know, microeconomics one of the two major branches of economics and deal with the study of decisions made by individuals and firms. We are all faced with choices in our daily life. When it comes to fulfilling personal needs, for instance, one must forego one thing to achieve the other. And as you will discover throughout this article, these decisions affect and are equally affected by the economy. We shall, therefore, be looking perfect and imperfect competition as principles of microeconomics.
Perfect competition is only theoretical. This means you will only read about a perfectly competitive market structure in books and texts, but you will never experience it in real life.
A market is said to be in perfect competition when:
- All the firms involved in the market sell an identical product. The product is said to be a ‘commodity’ or ‘homogeneous.’ Every player is aware of what they and others are giving to or getting from the market.
- The firms are price takers. Since they are selling the same product, they cannot influence the market price of their individual products.
- Market share does not influence the price. However, small or big a firm is, they share similar pricing with others. In any case, they are only price takers.
- Buyers have complete information. Perfect information means buyers already know the past, future, and present of the product being sold and what each firm is charging.
- There are entirely free resources for this information.
- There is no barrier to entry into or exit from the market.
In contrast to this, perfect competition is the imperfect competition where a market violates the abstract tenets of perfectly competitive environments. All markets exist beyond the boundaries of ideal competition; hence they are categorized as imperfect. The modern concept of imperfect vs. perfect competition comes from the Cambridge classical culture of post-classical economic thought.
How does the perfect competition work?
As stated, completely perfect competition does not exist. However, markets like commodities, such as oil or wheat, are highly competitive and liquid. They are, therefore, the closes the world can get to perfectly competitive markets.
This market is considered an “ideal type” or a market that bears the comparison for real-market structures. Theoretically, perfect competition is the direct opposite of a monopoly. For the case of monopoly, there is only a single firm in charge of producing and supplying a product or service, and they can price it any way they want. The consumer has no alternative, and would-be competitors cannot enter the market.
In perfect competition, there is equilibrium between demand and supply. In other words, there are many buyers and sellers; hence the price is determined by these variables. Companies don’t reap much profit, but just enough to stay in business. Any attempt to gain excess profits will attract other firms in the market, driving profits even lower.
Large, homogeneous markets
In a perfect competition setting, there is enough supply and demand. The sellers are mostly small companies, as opposed to large corporations that can control prices. The product has minimal differences in terms of capabilities, features, and prices. Hence, buyers cannot differentiate between the products by only looking at the physical appearance like size and color or intangible values like the brand. And because there is a large population of both buyers and suppliers, supply and demand remain fairly constant within the market. Also, a buyer has a chance to substitute specific products from one firm for another's easily.
People and firms make decide based on available information. And in this case, there is information about the ecosystem and competition in a market that creates a significant advantage. For example, when there is knowledge about component sourcing and supplier pricing, individual firms may grow faster. Information about patents and researcher plans can have companies in pharmaceutical and technology initiate strategies that beat their competition.
Such issues are not in a perfectly competitive market. This is because the information is equally and freely available. This means, every firm produces its goods and serves at precisely the same rate and using the same techniques as the other companies in the same market.
In many instances, governments play a significant role in market systems. They impose regulations and price controls that shield both suppliers and consumers. Hence, they can control how firms enter or exit the markets. For instance, there are laws governing how the pharmaceutical industry does its research, product, and sale of drums.
These rules call for hefty capital investments, including employees such as legal advisors and quality assurance, as well as infrastructure like machinery. When the costs are put together, it becomes costly for a company to bring a drug on the market.
The technology industry, on the other hand, works with less oversight. This means starting a company in technology is much easier and cheaper, and doing so in the pharmaceutical industry.
In a perfectly competitive environment, these controls do not exist. There is no restriction on how firms enter and exit the market.
Transportation is cheap and efficient
In perfect competition, there are no issues with transport. Companies do not pay a lot for transport. As such, they can reduce the production costs as well as cut back the delays on transportation.
Example of a perfectly competitive market
A perfectly competitive market is theoretical. Hence, finding an excellent example of real-life is not easy. But there are variants in the society that may bring out something close to perfect competition.
Think of a farmers’ market. Here, you will find many small buyers and sellers. There is often very little difference between their products, prices, and what others are selling. There is even no difference in the branding and packaging of the products. Thus, if one farm goes out of business, it may not leave any impact on the average price of the markets.
Also, consider supermarkets. In many cases, they stock the aisles in the same way from a set of companies. They all sell the same products, with little to no difference, including packaging, branding, and pricing.
Consider also the market for unbranded products. They are only cheaper versions of well-known products, and there no added value. Hence they retail at the same prices with no major differences generally.
Technology has also created another category of perfectly competitive markets. For instance, you will find all types of e-commerce sites offering similar products. Mostly, it is all about what they are selling. The internet is free and largely available; entry and exit are easy.
Do perfect competition models have disadvantages?
From an idealistic point of view, the perfect competition offers the perfect framework for the market establishment. However, the market is full of flaws and disadvantages. For instance, there is a lack of innovation. Firms are motivated to create better products and set themselves apart as an incentive to gain a more significant market share. For in perfect competition, a firm can possess dominance, hence no need for playing smart.
Demand and supply draw for fixed profit margins. Hence, a firm cannot charge premiums for their products and services. In such an environment, it would be very difficult for a company like Apple Inc to survive. Their phones are pricier than the competition.
This section introduces the student to how monopolies form (and) barriers to entry, the impact of output and price on profit-maximization, and monopolistic competition.
Before we go further, let's step back a bit into the history of monopoly. In 1773, one firm, East India Company, was on the verge of a big fail. It was going through a hard time for financial difficulties. But the British Parliament came to save the failing company by introducing the Tea Act. The law continued taxing tea and made the East India Company the only recognized tea supplier to American colonies. This step gave them legal monopoly power. But by November the same year, Boston citizens couldn’t take anymore. They refused tea unloading, stating, “no taxation without representation.” To cut the story short, things did not go very well.
A similar situation happened on the eve of the American Civil War in 1860 with the U.S cotton industry. The South was considering receding from the Union; hence they hoped to leverage on Britain imported coffee. But cotton –merchants refused to export their cotton; hence failing what was termed as “The King Cotton” strategy in 1861. Britain opted to other sources, but this affected the confederacy’s gold supply.
What we learn here is that monopoly sellers often don’t see a threat to their positions in the market. But it is all about the attribute of imperfect competition markets.
As we have learned above, a perfect competition environment is where no firm has market power. They only respond to market prices and changes. A monopolistic market is the opposite, where there is no competition at all. There is only one producer on the market, and they are responsible for changing the prices as they want. The consumer has no choice but to accept what they are given.
It is, however, important for a monopoly on being concerned about how the consumers will purchase their products. However, a monopolist never has to worry about the actions of other firms. They are not price-takers, as we saw with perfect competition.
In imperfect competition, the market violates tenets of the perfect competition. In other words, it allows some firms to have a stronger command on the market than others. It is an economic market that ignores the standards of purely competitive markets.
In this case, companies come up with different products and services. They set their own price, and each fight for market dominance. Apart from monopolies, they are also found oligopolies, monopolistic, monopsonies, and oligopsonies.
A single-priced monopoly is a situation where a company must charge the same price to all consumers. In this case, the company majorly relies on aggregate demand.
Consider Oakley, Ray-Ban, and Persol sunglass companies. They are all owned by Luxottica, an eyewear company based in Italy that makes about 70% of all brand eyewear. This means the company dominates the market. But it is not a single-price monopoly. This is major because it bears different brands targeting different consumers; hence, they practice a form of price discrimination. If the company sold only a single category of glasses, they would have to sell at the same price, even if they owned 100% of the market. If they decided to lower the price, it would have to be for all consumers, and that would have a huge impact on their revenue. In a monopoly, price reduction leads to losing revenue, and the more sales they make, the greater the loss.
One of the drawbacks of imperfect competition is government intervention. Well, this may not be a limitation per se, considering that government regulations can help correct monopoly. They set policies that increase the quantity. But as we may already know taxes and price floors negatively affects quantity, which they will not work here. A subsidy, on the other hand, would increase market surplus, but it would be very difficult to implement. Perhaps the only option for this situation would be the price ceiling. Thus it will be reasonably applicable in reducing the deadweight loss. The most important thing here is sustaining the market equilibrium while protecting the consumers and the firm.
Author: James Hamilton