What is Imperfect Market?

Imperfect market structure is part of microeconomicsMicroeconomicsMicroeconomics is a ‘bottom-up’ approach where patterns from everyday life are pieced together to correlate demand and supply.read more in which companies sell different products and services, unlike perfectly competitive markets where homogeneous products are sold, in real-world most companies belong to imperfect market having some pricing power with high barriers to entry which results in companies making greater profit margin as every company tries to differentiate their products and services through innovative technologies and advertisement.

Top 4 Types of Imperfect Market

Imperfect market structure can be broken down into four types:

#1 – Monopolistic Market

It is a highly competitive market, with product differentiation being the main characteristic that helps companies post greater profit margins. Advertising is an important part of monopolistic competition. Advertising is the avenue to convince consumers there is a difference between the products in the same product category. The extent to which the market participates in product differentiationProduct DifferentiationProduct differentiation refers to making a product look attractive and different from other products in the same class. Marketers highlight the distinguishing features in the product commonly through packaging or a good design, which helps communicate the benefitting factors to the shoppers.read more determines pricing powerPricing PowerPricing power refers to the power of an entity to choose the desired price for its product or service without the risk of losing its demand or customer base. Generally, it is an attribute of companies that are market leaders or monopolies.read more.

  • There is a large number of potential buyers and sellers.The barrier to entry is quite low, which results in easy entry and exit from the market.The product offered by each seller is a close substitute for the product offered by other sellers.

Restaurant businesses are part of the monopolistic market where the barrier to entry is quite low because of which there are so many restaurants in each locality. Each restaurant tries to differentiate from others through advertising and marketing strategies like a multi-cuisine restaurant or specialty food joints of Dominos or McDonald’s’.

#2 – Oligopoly Market

Compared to the monopolistic market, an oligopoly market has higher barriers to entryBarriers To EntryBarriers to entry are the economic hurdles that a new entrant must face in order to enter a market. For example, new entrants must pay fixed costs regardless of production or sales that would not have been incurred if the participant had not been a new entrant.read more. The important characteristic of oligopoly markets is that few firms control the majority of market share (mostly 2 or 3 firms). In addition, these firms are interdependent for pricing decisions, which means price change by one firm results in price change by its competitors. If the price changePrice ChangePrice change in finance is the difference between the initial and final values of an asset, security, or commodity over a particular trading period.read more is not adopted quickly, the firm will lose customers and market share.

Collusive agreements help companies decide the supply of a product and get a better price for their products. Since only a few companies are present in these types of markets, the chances of firm collusion are very high. Therefore, it increases the profit margin for companies and reduces future cash flowCash FlowCash Flow is the amount of cash or cash equivalent generated & consumed by a Company over a given period. It proves to be a prerequisite for analyzing the business’s strength, profitability, & scope for betterment. read more uncertainty. Such collusive agreements between a group of companies are called cartels.

  • Firms typically have substantial pricing power.Only 2 or 3 big firms exist because of a high barrier to entry & exit and competition.There is less potential competition from firms outside the cartelThe CartelA cartel is a group of producers of goods or suppliers of services formed through an agreement amongst themselves to regulate the supply of goods or services with the basic intent to illegally regulate the prices or restrict competition regarding the said goods or services.read more.

A well- known example for an oligopolyExample For An OligopolyThe aviation, media, pharmaceutical, and telecommunications industries are all examples of oligopoly.read more market is the Organization of the Petroleum Exporting Countries (OPEC), where very few oil-producing countries meet and decide on crude oil supply worldwide and indirectly control crude oil prices.

#3 – Monopoly Market

As the name suggests, in the monopoly market, a single firm represents the entire market with significant barriers to entry for other firms. The distinguishing characteristics of a monopoly are that the firm produces highly specialized products that no other firm can produce, because of which there is no competition at all.

Another reason for a monopoly is ownership of key resources like coal mines. A monopoly is also created when the government grants license or franchise rights to a few companies (like a license for making defense equipment).

  • Firms have considerable pricing power.The product offered by the sellers has no close substitute.Product is differentiated through non-price strategies such as market research and advertising.

  • Microsoft ltd has a monopoly in an operating system. Most users worldwide use a Microsoft operating system which helps the company maintain its market share. Entry by a new company is not easy because of the copyright and patents owned by Microsoft.After getting US-Food and Drug administration (FDA) approval for medicine, pharmaceutical companies like Abbott Laboratories get the right to sell the medicine exclusively for seven years. During these seven years, no other company could sell the same medicine in the market, thus creating a monopoly through the research and development of medicine.

#4 – Monopsony Market (only one buyer of a product)

In the monopsony market, the single buyer is a major purchaser of goods and services offered by many sellers. Since a single buyer and many sellers are available, buyers have significant control over the market, and in some cases, prices are decided by the buyer rather than the sellers.

Monopsony buyer’s power generally exists in the factor marketFactor MarketA factor market is a resource market that allows business firms to purchase factors of production such as land, labor, raw materials with which they produce goods and services. In simple words, it is a market for the factors of production.read more, the market for production services, which includes labor, capital, land, and raw material used to make products.

  • A buyer’s monopoly is possible because sellers have no alternative buyers to sell their services. A classic example is coal mining in towns. A company that owns the coal mine (employer or buyer) can set lower wages for a worker in mines (seller of skills) because they face no competition from other employers in hiring the worker.Monopsony or buyer’s monopoly has high barriers to entry because of high start-up costs and decreasing the average total cost of existing companies.Firms in monopsonyMonopsonyMonopsony is a market condition with a single buyer and multiple sellers. It is an imperfect market condition—the single buyer is the controlling entity. Similar to monopoly, where a single seller dominates and controls product price. In a monopsony, a single buyer determines the factor price. read more can capture above-normal profits and a large share in total gain at the expense of low wages and below-average working conditions.

Supermarket chains like Walmart or Tesco have greater purchasing power and often negotiate with suppliers to buy at lower prices. Suppliers like Famers or milk producers don’t have an alternate option to sell products and agree to price negotiation. This effective supermarket strategy to buy at low from the supplier and sell at high to shoppers help them post superior profits and gain market share.

Conclusion

Real-world markets move from perfect competitionPerfect CompetitionPerfect competition is a market in which there are a large number of buyers and sellers, all of whom initiate the buying and selling mechanism. Furthermore, no restrictions apply in such markets, and there is no direct competition. It is assumed that all of the sellers sell identical or homogenous products.read more to pure monopoly. Imperfect markets cover the area between a perfect market to a pure monopoly, with most companies falling under oligopolyOligopolyAn oligopoly in economics refers to a market structure comprising multiple big companies that dominate a particular sector through restrictive trade practices, such as collusion and market sharing. Oligopolists seek to maximize market profits while minimizing market competition through non-price competition and product differentiation. read more or monopolistic competition. The main purpose of companies is to maximize profits and gain market share through many non-price strategies like new technology and innovative products.

This has been a guide to an Imperfect Market and its definition. Here we discuss the top 4 imperfect market types and characteristics and examples. You can learn more about investment from the following articles –

  • Price EfficiencyForward MarketInefficient Market TypesMonopoly vs OligopolyNormal Goods vs Inferior Goods