Imperfect Competition

Definition

Imperfect competition refers to a market structure where firms have some degree of market power, allowing them to influence prices and output rather than being price takers. This situation arises in markets that deviate from perfect competition due to factors like product differentiation, limited information, and barriers to entry. It contrasts sharply with classical trade theories, which often assume perfectly competitive markets, and highlights the complexities in modern trade theories where firms strategically interact within the global economy.

5 Must Know Facts For Your Next Test

1. Imperfect competition can manifest in various forms, including monopolistic competition, where many firms sell similar but not identical products.
2. Firms in an imperfectly competitive market can set prices above marginal cost, leading to higher profit margins compared to perfect competition.
3. Barriers to entry in imperfect competition can include high startup costs, brand loyalty, and regulatory requirements, which protect existing firms from new competitors.
4. Product differentiation is a key feature of imperfect competition, allowing firms to create unique offerings that appeal to specific consumer preferences.
5. In international trade, imperfect competition affects how countries engage with each other, as firms may compete on factors beyond just price, such as quality and branding.

Review Questions

• How does imperfect competition differ from perfect competition in terms of pricing and market power?
  • Imperfect competition differs from perfect competition primarily in that firms possess some level of market power, enabling them to influence prices rather than simply accepting them. In perfect competition, numerous firms offer identical products, leading to price taking behavior; however, in imperfect competition, firms can set prices above marginal costs due to product differentiation or reduced competition. This allows firms to earn economic profits over time, which is not possible in a perfectly competitive market.
• Discuss how barriers to entry contribute to the presence of imperfect competition in a market.
  • Barriers to entry are crucial in establishing imperfect competition because they prevent new firms from entering the market easily. High startup costs, established brand loyalty among consumers, and regulatory hurdles create significant obstacles for potential entrants. As a result, existing firms can maintain higher prices and profits due to reduced competition. This dynamic enables firms within the market to exert greater control over pricing and output levels compared to a perfectly competitive environment.
• Evaluate the implications of imperfect competition on international trade dynamics among countries.
  • Imperfect competition has significant implications for international trade dynamics as it alters the way countries interact economically. Firms operating under imperfectly competitive conditions may engage in strategic behaviors such as price discrimination or export strategies that maximize their market share while maintaining higher prices. This can lead to trade policies that favor certain industries or products, as governments may protect domestic firms from foreign competitors through tariffs or subsidies. Consequently, these behaviors can distort trade patterns and impact global economic relations.

Related terms

Monopoly: A market structure where a single firm dominates the entire market, significantly influencing prices and supply.

Oligopoly: A market structure characterized by a few firms that hold significant market power and whose decisions affect each other, leading to strategic interactions.

Price Discrimination: The practice of charging different prices to different consumers for the same good or service, often enabled by imperfect competition.