What is Imperfect Market?
Imperfect market structure is part of microeconomics in which companies sell different products and services unlike perfect 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 usually the avenue pursued to convince consumers there is a difference between the products in the same product category. The extent to which the market participates are successful in product differentiation determines pricing power.
Main Characteristics of Monopolistic Market
- 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.
Example of Monopolistic Market
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 advertisement and marketing strategy 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 entry. The important characteristic of oligopoly markets is that few firms control the majority of market share (mostly 2 or 3 firms). These firms are interdependent on each other for pricing decision, which means price change by one firm results in price change by its competitors, if the price change is not adopted quickly then the firm will lose out on customer and market share.
Since there are only a few companies present in these type of markets, chances of firm collusion are very high as it increases the profit margin for companies as well as reduced the future cash flow uncertainty. Such collusive agreements between a group of companies are called cartels. Collusive agreements help companies decide the supply of a product and get a better price for their products.
Main Characteristics of Oligopoly Market
- Firms typically have substantial pricing power.
- Only 2 or3 big firms exist because of a high barrier to entry & exits and competition.
- There is less potential competition from firms outside the cartel.
Example of Oligopoly Market
Well- known example for an oligopoly market is the Organization of the Petroleum Exporting Countries (OPEC) where very few oil-producing countries meet and decide crude oil supply worldwide and hence indirectly control crude oil prices.
#3 – Monopoly Market
As the name suggests, in the monopoly market 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.
Monopoly companies are formed because of many reasons like patents or copyrights. Patent and copyright are given to companies as a reward for investment in research and development of products (like medicine patents).
Another reason for a monopoly is ownership of key resources like coal mines ownership. A monopoly is also created when government grants license or franchise rights to few companies (like a license for making defense equipment).
Main Characteristics of Monopoly Market
- 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.
Example of Monopoly Market
- Microsoft ltd has a monopoly in an operating system. Most user worldwide uses a Microsoft operating system which helps the company maintain its market share. Entry by a new company is not easy because of copyright and patent own by Microsoft.
- Pharmaceutical companies like Abbott Laboratories after getting US-Food and Drug administration (FDA) approval for medicine, get the right to sell the medicine exclusively for 7 years. During these 7 years, no other company can sell the same medicine in the market thus creating a monopoly through 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 sellers.
Monopsony buyer’s power generally exists in the factor market, that is, the market for services of production which includes labour, capital, land and raw material used to make products.
Main Characteristics of Monopsony Market
- Buyer’s monopoly is possible because sellers have no alternative buyers to sell their services. A classic example is coal mining in towns, where a company that owns the coal mine (employer or buyer) are able to 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 monopsony are able to capture above-normal profits and a large share in total gain at the expense of low wages and below-average working conditions.
Example of Monopsony Market
Supermarket chains like Walmart or Tesco which have greater purchasing power and often negotiate with suppliers to buy at lower prices. Suppliers like Famers or milk producer who don’t have an alternate option to sell products and has to agree to price negotiation. This effective strategy of a supermarket to buy at low from the supplier and sell at high to shopper help them post superior profits and gain market share.
Real-world markets move between the perfect competition to pure monopoly. Imperfect markets cover the area between a perfect market to pure monopoly with the majority of companies falling under oligopoly 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 what is imperfect market and its definition. Here we discuss top 4 types of imperfect market along with characteristics and examples. You can learn more about investment from the following articles –