In economics, imperfect competition refers to a situation where the characteristics of an economic market do not fulfill all the necessary conditions of a perfectly competitive market. Imperfect competition causes market inefficiencies, resulting in market failure. Imperfect competition usually describes behaviour of suppliers in a market, such that the level of competition between sellers is below the level of competition in perfectly competitive market conditions.

The competitive structure of a market can significantly impact the financial performance and conduct of the firms competing within it. There is a causal relationship between competitive structure, behaviour and performance paradigm. Market structure can be determined by measuring the degree of suppliers' market concentration, which in turn reveals the nature of market competition. The degree of market power refers to firms' ability to affect the price of a good and thus, raise the market price of the good or service above marginal cost (MC).

The greater extent to which price is raised above marginal cost, the greater the market inefficiency.  Competition in markets ranges from perfect competition to pure monopoly, where monopolies are imperfectly competitive markets with the greatest ability to raise price above marginal cost.

Demand curves

left|thumb|(a) Demand Curve under Perfectly Competitive market (b) Demand Curve under Imperfectly Competitive market

The imperfect market faces a down-ward sloping demand curve in contrast to a perfectly elastic demand curve in the perfectly competitive market. This is because product differentiation and substitution occurs in the market. It is very easy for a consumer to change their seller which makes the consumer sensitive to price. The Law of demand also plays a very vital role in this market. As price increases, quantity demanded decreases for the given product. The demand curve in perfectly competitive and imperfectly competitive market has been illustrated in the image on the left.

  • Sellers are price takers, not price makers;
  • Prices are influenced by supply and demand such that P=MC, via Pareto Efficiency and the Invisible Hand;
  • Large number of sellers in the market such that no one firm has significant market power;
  • Little to no barriers to entry and exit;
  • Buyers and sellers have full information;
  • Negligible search costs;
  • Product homogeneity and divisibility;
  • Lack of collusion between firms;
  • Absence of externalities including increasing returns to scale.

Conditions of imperfect competition

If ANY of the above conditions of perfect competition are dissatisfied, the market is imperfectly competitive. Moreover;

If ONE of the following conditions are satisfied within an economic market, the market is considered "imperfect":

  • Market firms are NOT price takers and hence have control over the pricing of their goods and services;
  • The market contains ONE seller or none;
  • There are barriers to market entry and exit;
  • There is information asymmetry between buyers and sellers;
  • The market's goods and services are heterogeneous or differentiated.

thumb|Monopoly firm maximises where MR = MC, but sets P > MC

Imperfect competition is inherent in capitalist economies. Firms are incentivised by profit, and hence undertake competitive strategies which reap the greatest revenue, by setting P > MC, at the cost of macroeconomic market efficiency.

Conversely, imperfect competition assumptions promote intervention in the international trade market. Assuming imperfect competition allows for economic modelling of policies to contain imperfectly competitive firms' market power, or for enhancing monopoly power in situations of national interest.

Oligopoly

In an oligopoly market structure, the market is supplied by a small number of firms (more than 2). Moreover, there are so few firms that the actions of one firm can influence the actions of the other firms. Due to the small number of sellers in the market, any adjustment of product quantity and pricing by an enterprise will affect its competitors and thus affect the supply and pricing of the whole market. Oligopolies generally rely on non-price weapons, such as advertising or changes in product characteristics. Several large companies hold large market shares in industrial production, each facing a downward sloping demand, and the industry is often characterized by extensive non-price competition. The oligopoly considers price cuts to be a dangerous strategy. Businesses depend on each other. Under this market structure, the differentiation of products may or may not exist. The product they sell may or may not be differentiated and there are barriers to entry: natural, cost, market size or dissuasive strategies.

In an oligopoly, barriers to market entry and exit are high. The major barriers are:

  • Patents;
  • Technology;
  • Economies of scale;
  • Government regulation (e.g. limiting the issuance of licences); and
  • Firm name recognition.

Duopoly

A special type of Oligopoly, where two firms have exclusive power and control in a market. Both companies produce the same type of product and no other company produces the same or alternative product. The goods produced are circulated in only one market, and no other company intends to enter the market. The two companies have a lot of control over market prices. It is a particular case of oligopoly, so it can be said that it is an intermediate situation between monopoly and perfect competition economy. Hence, it is the most basic form of oligopoly. A monopolist faces a downward sloping demand curve. Thus, as the monopolist raises its price, it sells fewer units. This suggests that when prices rise, even monopolists can drive away customers and sell fewer products. The difference between monopoly and other models is that monopolists can price their products without considering the reactions of other firms' strategic decisions.

Hence, a monopolist's profit maximising quantity is where marginal cost equals marginal revenue. At this point:

  • Output is below the level of a perfectly competitive market; but
  • Price is above marginal cost. A natural monopoly occurs when it is cheaper for a single firm to provide all of the market's output.

Governments often restrict monopolies through high taxes or anti-monopoly laws as high profits obtained by monopolies may harm the interests of consumers. However, restricting the profits of monopolists may also harm the interests of consumers, because companies may create unsatisfied products that are not available in new markets. These products will bring positive benefits to consumers and create huge economic value for enterprises. Tax and antitrust laws can discourage companies from innovating.

Intensity of price competition

The intensity of price competition is another good measure of how much control a firm within a market structure has over price. The Herfindahl Index provides a measure of firm concentration within a market and is the sum of the squared market shares of all the firms in the market (Herfindahl Index = (S<sub>i</sub>)<sup>2</sup>, where S<sub>i</sub> = market share of firm i) . Large companies are given more weight in the index (unlike the N-concentration ratio). The value of the index ranges from 1/N to 1 (where N is the number of firms in the market). Thus, the more concentrated the market is, the larger the value of the Herfindahl Index will be.