Imperfect competition

• 1. Defining Market Structures

  ›

  In 1992, an economist in St Lucia, Australia presented a slide showing how market structures determine financial performance. The slide stated that imperfect competition occurs when market characteristics fail to meet the necessary conditions of perfect competition. This failure results in market inefficiencies and often leads to market failure. Suppliers in these markets exhibit behavior where the level of competition falls below what is seen in perfectly competitive conditions. The degree of market power refers to a firm's ability to affect the price of a good. When firms raise prices above marginal cost, they create greater market inefficiency. Competition ranges from perfect competition to pure monopoly. Monopolies represent the most extreme form of imperfectly competitive markets with the greatest ability to raise prices.

  13

• 2. Conditions Of Competition

  ›

  Economists developed assumptions for perfect competition to guide economic policy regarding welfare and efficiency analysis. These assumptions include sellers acting as price takers rather than price makers. Prices are influenced by supply and demand so that price equals marginal cost via Pareto Efficiency. A large number of sellers exists in the market such that no single firm holds significant market power. Barriers to entry and exit remain little to none throughout the process. Buyers and sellers possess full information about all transactions. Search costs become negligible for participants in the market. Product homogeneity and divisibility characterize the goods available. Collusion between firms does not occur within this structure. Externalities including increasing returns to scale are absent from the model. If any of these conditions fail, the market becomes imperfectly competitive.

  134

• 3. Types Of Imperfect Markets

  ›

  Four broad market structures result in imperfect competition according to the University of Queensland lecture notes. Monopolistic competition features many buyers and sellers offering some product differentiation. Firms compete by selling differentiated products that are highly substitutable but not perfect substitutes. Oligopoly involves a small number of sellers where one firm's actions influence others. Duopoly represents a special case with two firms holding exclusive power over a market. Monopoly consists of only one supplier facing many buyers with complete control over pricing. Enterprises entering monopolistic competition may realize profit increases or losses in the short term. They will eventually achieve normal profit in the long run if prices offset fixed costs above marginal cost. Each firm shares a small percentage of the total monopolistic market and has limited control over prevailing prices. The main difference between monopoly competition and perfect competition lies in the paradox of excess capacity and price exceeding marginal cost.

  578

• 4. Measuring Market Power

  ›

  The Herfindahl Index provides a measure of firm concentration within a specific market. This index equals the sum of squared market shares of all firms operating in the industry. Large companies receive more weight in this calculation unlike the N-concentration ratio method. Values range from 1/N to 1 depending on the number of firms present. Markets below 0.20 show fierce price competition while those above 0.60 display light or nil intensity. Oligopolies typically fall between 0.20 and 0.60 indicating moderate rivalry levels. Monopolistic competition markets also stay below 0.20 but intensity depends on product differentiation factors. Perfect competition markets remain below 0.20 showing fierce competitive pressure throughout. The Herfindahl Index helps quantify how much control a firm holds over pricing decisions. It reveals whether a market structure allows for significant price manipulation by dominant players.

  26

• 5. Policy Implications

  ›

  Foreign trade policies utilizing perfect competition assumptions advocate for minimal government intervention globally. Subsidies become harmful under these conditions while improvements to terms-of-trade serve as primary import protection points. Conversely, imperfect competition assumptions promote active intervention in international trade markets. These models allow economists to contain market power held by imperfectly competitive firms. They also enable enhancing monopoly power when national interests require such measures. Assumptions about perfect versus imperfect competition directly influence policy choices domestically and internationally. Economists dispute whether economic policy should be based on perfect competition assumptions since no pure examples exist. The argument for assuming perfect competition prevails due to widespread logic use despite lacking substantial consistent models. Imperfect theorists argue that policies based on perfect competition assumptions prove ineffective in real-world scenarios.

  611

• 6. Sources Of Market Dominance

  ›

  Market power emerges from several specific factors identified in the University of Queensland lecture materials. Control over inputs gives organizations authority over important resources like Sydney Harbour operations. Copyrights and patents allow health industry companies to become sole legal sellers of major drugs. Network economies create monopolies where product value increases as more people use them. Instagram's popularity grew precisely because its usage increased among consumers. Government licenses can create monopolies such as Yosemite Hospitality running a lodge in Yosemite National Park. Patents protect technology and innovation while creating barriers to entry for competitors. Natural monopolies occur when it is cheaper for one firm to provide all market output. Barriers include market size constraints, control of raw materials, and dissuasive strategies used by existing firms. These sources explain why some firms achieve significant pricing power within their respective industries.

  26