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Imperfect Competition in the Markets

Dec 17, 20226 min read

Authors: Gabriel Angelo C. Abuel, Jose Benjamin J. Dela Cruz, Maria Angela T. Tabago, Naomi Chyla G. Choo


Imperfect competition describes a market condition that does not meet the assumptions of a perfectly competitive market. This means that companies in an industry may have unequal market shares and influence on price, restricted ability to enter/exit the market, etc., creating market inefficiencies that result in loss of economic value. This type of market condition arises as a result of businesses selling differentiated products or services, setting their own prices instead of having a price set by supply and demand, and having strong barriers to entry and exit which makes it hard for new companies to challenge them (Liberto, 2021). Consumers having inadequate information about products and prices also characterize imperfect competition. Imperfect competition can be found in the following market structures: monopolies, oligopolies, monopolistic competition, monopsonies, and oligopsonies (Depersio, 2021).


It is important to understand this concept because textbook models of perfect competition are not always applicable in practice due to disparities in manufacturing, marketing, and selling approaches across various industries (Gordon, 2022), among other factors. Most businesses that both investors and everyday consumers encounter on a daily basis operate under market structures exhibiting imperfect competition.


Market Structures with Imperfect Competition

  • Monopoly

Monopoly is a market structure wherein a single seller or producer assumes a dominant position in the industry they are in. Companies become monopolies by controlling the entire supply chain (production to sales), or by buying out its competitors. Monopolies often arise in industries with economies of scale, as companies are able to produce mass quantities at lower costs per unit compared to others (Hayes, 2022b). Since there is no competition and consumers have no other choice but to buy the monopolist’s product, the seller is the price maker. Market conditions do not solely determine price; the monopolist decides the price at which its product will be sold as it has sole power over supply. It can also change the price at any time, without giving notice to consumers (Depersio, 2021). The ability of monopolies to be price makers may theoretically mean higher short-term profits if they set the price much higher than costs.


One significant example of a monopoly in the Philippines is MERALCO, which is an economy of scale. However, monopolies are often heavily regulated, especially in utilities sectors, to limit the prices faced by consumers. This means that they are not always free to change prices at any time, and the improvements in profit margins may not happen to the extent expected by investors.


  • Oligopolies

On the other hand, an oligopoly is a market structure where there are two or more sellers in a particular industry. This collection of firms may work together to set a price that benefits every member of the oligopoly. They sometimes intentionally conspire such that they form a cartel or unintentionally where a company simply adjusts the price accordingly to match the price changes from another company (‘Oligopoly defined,’ 2022). Similar to a monopoly, prices in an industry are not solely determined by external market conditions but rather by a small number of companies. In an oligopoly, it is usually difficult for new and smaller companies to enter due to barriers which maintain the noncompetitive market. Innovations are also not always stimulated because products or services do not have a large number of direct substitutes (‘Oligopoly definition,’ 2022). This type of market structure usually exists in the telecommunications, gas, and airline industries (Hayes, 2022a).


Notable examples of oligopolies include the consumer tech industry which counts Apple, Microsoft, and Google as among the few companies with the bulk of market share. Another is the credit card or payment services sector, with Visa, MasterCard, and Amex dominating the market. All of these companies have shown high growth in the past decade, with most even beating the S&P Index (Miles, 2017), which tracks the stock performance of the 500 largest companies listed on US stock exchanges. These oligopolistic corporations have consolidation and scale (Bradley, 2022), without regulations and other limitations that may be stricter on monopolies. However, there are still some regulations on cartels and price fixing which may affect certain industries.


  • Monopolistic Competition

Monopolistic competition is a market structure that lies between perfect competition and a monopoly (Hutchinson, 2017). It occurs when there are multiple competing sellers, like in perfect competition, but these products and services are similar rather than completely the same. These products can be differentiated by certain features such as their physical qualities (flavor, unique design, etc.), abstract qualities (marketing, branding, etc.), or selling locations that make the products distinctive in the buyer’s perception (Hutchinson, 2017). Since there is no monopoly that dominates the market, new companies can enter the market, introducing competition that can potentially bring down prices faced by consumers. Product differentiation also gives them an opportunity to choose from a wide variety of products according to preference.


Nevertheless, this market structure may not be purely beneficial to consumers. It should be noted that the products are not perfect substitutes, and other factors such as brand loyalty may come into play due to the distinguishing traits of each, which means that companies will not necessarily have equal market share. These could have implications on their influence on price, unlike in perfect competition where sellers’ actions have no effect on price. If companies in monopolistic competition are assured that patrons will still prefer the specific features of their product over others, they can raise prices to a certain extent.


Common examples of monopolistic competition happen in the fast food industry. Fast food companies like McDonald's and Jollibee offer similar products like burgers and fries but these products are differentiated in one way or another. Diners would consider Burger McDo and YumBurger similar but not substitutable due to overall taste, quality of ingredients, branding, or other factors. The mentioned companies can raise prices, and consumers who prefer one could still continue to consume either Burger McDo or YumBurger despite the price changes.


  • Monopsony and Oligopsony

Unlike monopolies and oligopolies, a monopsony is a market structure where there is a single buyer that dominates the market (Young, 2022). Monopsonists are in control of the market because they are usually the only ones who have the power and wealth to purchase the products in a given market. The situation gives them the leverage to dictate demand, and thus the price at which they will buy goods or services offered by multiple producers. This market structure usually results in producers selling at a generally lower price point. For example, Business A is the sole distributor that buys produce from rice farmers. Hoping to sell their produce, farmers in the area may be forced to sell at a lower price set by Business A, even if it means getting lesser or even no profit.


On the contrary, oligopsony is a market structure that acts like a monopsony but has a few buyers instead. It can be considered the opposite of an oligopoly because the buyers dominate the market instead of the sellers. Monopsonies and oligopsonies can also exist in the labor market where one or few companies hire the majority of the workforce of a particular job. This usually happens in the tech industry where some tech companies are the only ones who hire for a specific type of job (‘How a monopsony,’ 2022). Workers do not have a choice but to comply with the wages and benefits offered by the company.


Conclusion

The conditions of perfect competition are not always attainable in real life. Suffice to say, most companies encountered by both consumers and investors will most likely behave more similarly to the aforementioned models with imperfect competition. They usually face different supply and demand curves, cost considerations, levels of government regulation, etc. These factors may influence their future strategies, and possibly affect performance as well. All of these should be kept in mind by investors for a more balanced evaluation of growth prospects.



References

Bradley, T. (2022, October 28). There's a good side to oligopolies and a lack of competition if

you're an investor . Financial Post. https://financialpost.com/investing/oligopolies-


Depersio, G. (2021, June 29). Perfect vs. imperfect competition: What’s the difference?.


Gordon, J. (2022, April 25). Perfect competition - explained. The Business Professor.


Hayes, A. (2022a, March 28). Oligopolies: some current examples. Investopedia.


Hayes, A. (2022b, August 2). What is a monopoly? Types, regulations, and impact on markets.


How a monopsony works: 3 examples of monopsonies. (2022, September 1).


Hutchinson, E. (2017). Principles of Microeconomics.


Liberto, D. (2021, August 30). Imperfect competition. Investopedia. Retrieved from


Miles, H. (2017, August 15). Global oligopolies - investing in concentrated businesses.


Monopolistic competition: definition, how it works, pros and cons. (2022, August 3).


Oligopoly defined: meaning and characteristics in a market. (2021, October 21).


Oligopoly definition: how an oligopoly works. (2022, October 23). MasterClass.


Young, J. (2022, September 14). Monopsony: definition, causes, objections, and example.


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