4.1 Introduction to Imperfectly Competitive Markets

What is Imperfect Competition?

In unit 3, we built up to a perfectly competitive market. These markets have many firm competing in a market with low barriers and a price set by the equilibrium in the market. Imperfect competition when one or more, of the assumptions we make in perfect competition change. For example, we may look at a market with few sellers and high barriers to entry, or only one seller. This unit will focus on how markets behave when they aren't perfect, and we'll be looking at how deadweight loss begins to appear.

The imperfectly competitive markets include monopoly, oligopoly, and monopolistic competition. 

1. A monopoly refers to the type of market that only has one firm that dominates the industry and sells a very unique product. Examples of monopolies include a small-town gas station, the Windows operating system for computers, DeBeers diamonds (the main diamond producer in the world), and the utility companies in your area.

2. An oligopoly refers to a type of market where there are a few large firms that dominate the industry (usually less than 10). Some examples of oligopolies include cable television services, cereal companies, automobile manufacturing companies, and cell phone companies.

3. A monopolistically competitive market is one that has a large number of sellers that offer differentiated products. Examples of monopolistic competition include restaurants, clothing companies, hairdressers, and makeup companies.

Characteristics of Imperfectly Competitive Firms

• Fewer, large firms in the industry
• Firms are "price makers"
• Higher barriers to entry means firms cannot enter as easily
• Firms earn long-run profits (except monopolistic competition, which break even in the long-run)
• Products that are sold are differentiated
• Non-price competition is used
• Firms are inefficient in the long-run
• Demand is greater than marginal revenue

The characteristic of price maker means that the firms have some or total control over the price at which they choose to sell their goods in the market. Just like all market structures, they set their output at the profit-maximizing point. But, the firms will charge consumers the highest price that they are willing and able to pay in the market. In all of these market structures, there are a limited number of firms in the industry, so that limits who consumers can buy products from.

Fun Fact! This is out of scope, but we actually measure market power by looking at how much a firm controls the price. This is quantitatively done by comparing the price to the marginal cost, since in perfect competition price exactly equals marginal cost (since P = MR and we produce where MR = MC). For more, look up the Lerner Index of Market Power

This lack of choice allows the firms to have more control over price in the market. All of these firms are faced with barriers to entry that prevent new firms from joining the industry. Since new firms cannot enter easily, there is less competition, which leads to firms being able to earn economic profits in the long-run.

In all of these imperfectly competitive markets, the products are differentiated which leads to non-price competition. Non-price competition is when companies use tools like advertising to promote their products. The fact that there is little to no competition leads to these types of firms being inefficient in the long-run, as they do not feel the pressure to produce at efficient levels. Finally, demand is greater than marginal revenue because, in order to sell another unit, the firm must lower the price of the next unit.

Example Barriers to Entry

Geography 🌍

There are several different types of barriers to entry in all of the imperfectly competitive markets. The first one is geography. A firm's location can allow them to control access to important factors of production. When a firm controls access to the factors of production, it gives them control over the production of a good, making it difficult for new firms to compete. Geography can also be a barrier if the firm is the only one in the area that offers a particular product.

Government 🇺🇸

The government serves as a barrier to entry by issuing things like patents and other protections. These allow firms and entrepreneurs to have exclusive rights to manufacture a product. When these are granted they make it difficult for new firms to enter the industry.

Common Use

This barrier of entry is the ability of a firm to use its brand name and reputation to maintain their customer base. When a firm acquires a reputation of being reliable and offering a good product, it becomes difficult for new firms to enter the industry and compete.

Economies of Scale 🏭

This is the ability of a firm to mass-produce their goods at low costs. As firms accumulate capital, they are able to mass-produce their products at the lowest cost possible. Since new firms have higher start-up costs, they have difficulty competing in the industry. This ensures that the dominant firms hold an advantage in earning the profits, making it difficult for new firms to enter the market.

High Fixed Costs

High fixed costs can be a barrier to entry for new firms because they may not have the financial resources to incur the upfront costs of entering the market. For example, if a new firm wants to enter the airline industry, they would need to invest in planes, hiring pilots and staff, and obtaining necessary licenses and certifications. These costs can be significant and may deter new firms from entering the market.