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4.1 Introduction to Imperfectly Competitive Markets

4 min readdecember 22, 2022

J

Jeanne Stansak

dylan_black_2025

dylan_black_2025

J

Jeanne Stansak

dylan_black_2025

dylan_black_2025

What is Imperfect Competition?

In unit 3, we built up to a . These markets have many firm competing in a market with low barriers and a price set by the in the market. 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 , or only one seller. This unit will focus on how markets behave when they aren't perfect, and we'll be looking at how begins to appear.

The imperfectly competitive markets include , , and .

1. A  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  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 . Examples of include restaurants, clothing companies, hairdressers, and makeup companies.

Characteristics of Imperfectly Competitive Firms

  • Fewer, large firms in the industry
  • Firms are ""
  • Higher means firms cannot enter as easily
  • Firms earn (except , which break even in the long-run)
  • Products that are sold are differentiated
  • is used
  • Firms are in the long-run
  • is greater than

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 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  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 in the long-run, as they do not feel the pressure to produce at efficient levels. Finally, is greater than 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 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

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.

Key Terms to Review (17)

Barriers to Entry

: Barriers to entry refer to obstacles that prevent or limit new firms from entering an industry or market. These barriers can be natural (such as high capital requirements) or created by existing firms (such as patents).

Deadweight Loss

: Deadweight loss refers to the economic inefficiency that occurs when the allocation of goods and services is not at the socially optimal point, resulting in a loss of total surplus.

Demand

: Demand refers to the quantity of goods or services that consumers are willing and able to buy at various price levels during a specific period. It reflects consumer preferences and their willingness to pay for products.

Differentiated products

: Differentiated products are goods or services that have unique characteristics or features that distinguish them from competing products in the same market. These differences can be based on quality, design, branding, or other factors.

Equilibrium

: Equilibrium refers to a state of balance or stability in the market where the quantity demanded by consumers is equal to the quantity supplied by producers.

High Fixed Costs

: High fixed costs refer to expenses that do not change regardless of the level of production or sales. These costs are incurred by a business even if it doesn't produce anything.

Imperfect Competition

: Imperfect competition refers to a market structure where there are multiple sellers and buyers, but they have some degree of control over the price and quantity of goods or services. This means that firms can differentiate their products or manipulate prices to gain an advantage.

Inefficient

: Inefficient refers to a situation where resources are not being used in the most optimal way, resulting in waste or inefficiency. It means that there is a better allocation of resources possible that would lead to higher overall productivity.

Lerner Index of Market Power

: The Lerner Index of Market Power measures the extent to which a firm can set prices above its marginal cost. It is calculated by subtracting the firm's marginal cost from its price, and then dividing that difference by the price.

Long-run profits

: Long-run profits refer to the sustained positive economic returns that a firm earns over an extended period of time. It is the result of a firm's ability to maintain a competitive advantage and generate higher revenues than its costs in the long term.

Marginal Revenue

: Marginal revenue refers to the additional revenue generated from selling one more unit of a good or service. It is calculated by dividing the change in total revenue by the change in quantity sold.

Monopolistic Competition

: Monopolistic competition refers to a market structure where there are many sellers offering differentiated products that are similar but not identical. Each firm has some degree of control over its own pricing.

Monopoly

: A monopoly refers to a market structure where there is only one seller or producer of a particular good or service, giving them complete control over the market and the ability to set prices.

Non-price competition

: Non-price competition refers to strategies used by firms to attract customers without changing the price of their products or services. This can include advertising, product differentiation, customer service, and other marketing techniques.

Oligopoly

: An oligopoly refers to a market structure where a few large firms dominate the industry and have significant control over prices and competition.

Perfectly Competitive Market

: A perfectly competitive market is a market structure where there are many buyers and sellers, all selling identical products, and no single buyer or seller has the power to influence the price.

Price makers

: Price makers are firms or individuals that have the ability to set the price of a product or service in the market. They have control over the supply and demand conditions, allowing them to influence prices.

4.1 Introduction to Imperfectly Competitive Markets

4 min readdecember 22, 2022

J

Jeanne Stansak

dylan_black_2025

dylan_black_2025

J

Jeanne Stansak

dylan_black_2025

dylan_black_2025

What is Imperfect Competition?

In unit 3, we built up to a . These markets have many firm competing in a market with low barriers and a price set by the in the market. 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 , or only one seller. This unit will focus on how markets behave when they aren't perfect, and we'll be looking at how begins to appear.

The imperfectly competitive markets include , , and .

1. A  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  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 . Examples of include restaurants, clothing companies, hairdressers, and makeup companies.

Characteristics of Imperfectly Competitive Firms

  • Fewer, large firms in the industry
  • Firms are ""
  • Higher means firms cannot enter as easily
  • Firms earn (except , which break even in the long-run)
  • Products that are sold are differentiated
  • is used
  • Firms are in the long-run
  • is greater than

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 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  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 in the long-run, as they do not feel the pressure to produce at efficient levels. Finally, is greater than 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 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

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.

Key Terms to Review (17)

Barriers to Entry

: Barriers to entry refer to obstacles that prevent or limit new firms from entering an industry or market. These barriers can be natural (such as high capital requirements) or created by existing firms (such as patents).

Deadweight Loss

: Deadweight loss refers to the economic inefficiency that occurs when the allocation of goods and services is not at the socially optimal point, resulting in a loss of total surplus.

Demand

: Demand refers to the quantity of goods or services that consumers are willing and able to buy at various price levels during a specific period. It reflects consumer preferences and their willingness to pay for products.

Differentiated products

: Differentiated products are goods or services that have unique characteristics or features that distinguish them from competing products in the same market. These differences can be based on quality, design, branding, or other factors.

Equilibrium

: Equilibrium refers to a state of balance or stability in the market where the quantity demanded by consumers is equal to the quantity supplied by producers.

High Fixed Costs

: High fixed costs refer to expenses that do not change regardless of the level of production or sales. These costs are incurred by a business even if it doesn't produce anything.

Imperfect Competition

: Imperfect competition refers to a market structure where there are multiple sellers and buyers, but they have some degree of control over the price and quantity of goods or services. This means that firms can differentiate their products or manipulate prices to gain an advantage.

Inefficient

: Inefficient refers to a situation where resources are not being used in the most optimal way, resulting in waste or inefficiency. It means that there is a better allocation of resources possible that would lead to higher overall productivity.

Lerner Index of Market Power

: The Lerner Index of Market Power measures the extent to which a firm can set prices above its marginal cost. It is calculated by subtracting the firm's marginal cost from its price, and then dividing that difference by the price.

Long-run profits

: Long-run profits refer to the sustained positive economic returns that a firm earns over an extended period of time. It is the result of a firm's ability to maintain a competitive advantage and generate higher revenues than its costs in the long term.

Marginal Revenue

: Marginal revenue refers to the additional revenue generated from selling one more unit of a good or service. It is calculated by dividing the change in total revenue by the change in quantity sold.

Monopolistic Competition

: Monopolistic competition refers to a market structure where there are many sellers offering differentiated products that are similar but not identical. Each firm has some degree of control over its own pricing.

Monopoly

: A monopoly refers to a market structure where there is only one seller or producer of a particular good or service, giving them complete control over the market and the ability to set prices.

Non-price competition

: Non-price competition refers to strategies used by firms to attract customers without changing the price of their products or services. This can include advertising, product differentiation, customer service, and other marketing techniques.

Oligopoly

: An oligopoly refers to a market structure where a few large firms dominate the industry and have significant control over prices and competition.

Perfectly Competitive Market

: A perfectly competitive market is a market structure where there are many buyers and sellers, all selling identical products, and no single buyer or seller has the power to influence the price.

Price makers

: Price makers are firms or individuals that have the ability to set the price of a product or service in the market. They have control over the supply and demand conditions, allowing them to influence prices.


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© 2024 Fiveable Inc. All rights reserved.

AP® and SAT® are trademarks registered by the College Board, which is not affiliated with, and does not endorse this website.