Imagine you want to buy a second-hand Toyota from someone who you met in an online marketplace for second-hand cars. To what extent can you negotiate the price and bring it down? Will the seller disclose all the information about the Toyota they want to sell to you? Are there many other sellers of second-hand Toyotas? Most importantly, is the price set by the overall market equilibrium, or can you influence it?
You will probably be able to bring down the price even if it’s just by £100. That means that you can influence the price. And the seller isn’t likely to disclose all the accidents they might have engaged in, but you still end up buying their car.
In this case, you just participated in an imperfect market. This explanation will help you understand everything you need to know about imperfect markets.
Characteristics of imperfect markets
You can think of an imperfect market as any market that does not meet the functions and characteristics of perfectly competitive markets. If a market doesn’t have the underlying theoretical conditions of a perfectly competitive market, then it is an imperfect market.
It’s almost impossible to find perfectly competitive markets in the real world as it is extremely difficult to meet all the conditions of such a market. Therefore, imperfect markets are quite common in the real world, and you can find them in many places.
An imperfect market contains buyers and sellers who can influence not just the price but also the production of goods and services. Additionally, those in an imperfect market don’t fully disclose all the information about their goods and services. It is quite difficult for other firms to join or exit these markets, therefore limiting the number of buyers and sellers.
In contrast, a perfect market contains infinitely many buyers and sellers, and none of those can influence the price— as the market equilibrium sets it.
Most people would think that trading in the stock market is close to participating in a perfectly competitive market as the price constantly moves depending on the demand and supply for an asset. However, the stock market is, to a great extent, imperfect. That is because there’s imperfect information about the assets as companies don’t share all the information with the public.
Differences between perfect and imperfect market in economics
To understand the differences between perfect and imperfect markets in economics, you need to start by understanding the underlying characteristics of a perfectly competitive market.
A perfectly competitive market has:
Infinitely many buyers and sellers.
No barriers to entering or leaving the market.
Their products are either identical or can be substituted.
None of the market participants can influence the price.
Perfect information about the goods and services.
These markets are hardly found in the real world as markets can’t meet all these characteristics. However, they do provide a useful way of understanding economics and the reasoning behind prices and market behaviours.
To learn more about the benchmark for the perfect market check our explanation on Perfect Competition.
Agricultural produce markets are probably the closest to perfect competition markets in the real world.
In the real world, goods and services are heterogeneous instead of homogeneous. Sellers always try to differentiate their products from others to gain market dominance. Not all the information about the products is presented to the buyer, and often the market participants influence the prices. This is what makes an imperfect market.
The easiest way to determine an imperfect market is by simply finding a characteristic of a perfect market that isn’t met.
Types of imperfect markets
There are different market structures in which the price or production can be influenced in different ways. Let's see some of the most common types of imperfect markets.
Monopoly
In this type of imperfect market, we only have one dominant seller that can influence the price of goods or services they produce. This influence enables the dominant seller to do so because there is no substitute for their products, so buyers are left without many choices.
For example, in the UK, a company is considered to have monopoly power if its market share is higher than 25%.
Google has over 90% of search engine traffic and can be considered a monopoly in the UK.
To learn more about this market structure check our explanation on Monopoly.
Oligopoly
In this market structure, there is a small number of firms with a very high market share. These firms can influence the price of their goods and services and provide huge barriers for new firms to enter the market.
Airbus and Boeing are good examples of oligopoly market structures. In this type of market, you have these two companies producing almost half of the world’s commercial aircraft.
To learn more about this market structure check our explanation on Oligopoly.
Monopolistic competition
Monopolistically competitive markets are types of imperfect markets that have many sellers that offer products for which there are no substitute and their products are not identical. All of these businesses compete with each other solely based on the differentiation of their product from others.
Monopsonies and oligopsonies
Monopsonies and oligopsonies are somewhat different from monopoly and oligopoly. The main difference is that in their case, instead of having many buyers, they have many sellers but few buyers, which then influences their prices.
There are many tobacco sellers in the world, but there are only a few large companies that produce cigarettes. These few companies are the buyers who buy from many tobacco sellers in the world. They can easily negotiate and bring down the prices.
Disadvantages of imperfect markets
Markets can become too concentrated or prices fail to keep pace with changes in the marketplace. In both ways, consumers end up being harmed. Therefore, an imperfect market can get quite harmful to an economy.
Some of the main disadvantages of imperfect markets are:
Some new businesses might come up with innovative ideas that help society in general, but it may be too hard to implement them if they were to enter an imperfect market— usually, these markets have tough entry barriers. They could also find it hard to establish themselves as a brand due to the harsh competition.
As in many types of imperfect markets, there is little competition. There are not many incentives for companies to keep developing and coming up with innovative products that would significantly benefit consumers.
Governments often interfere in cases where there are imperfect markets that significantly harm consumer welfare. They do so by providing new regulations to the markets through fiscal policy or monetary policy. One of the most common types of regulation includes antitrust laws. However, government intervention is not always the best remedy to imperfect markets. This is because government policy could also be flawed. Government actors may not have the right information at hand to intervene correctly.
To learn more check our explanation on Government Intervention in Markets.
Advantages of imperfect markets
Although imperfect markets can harm consumers and economic welfare in general, they also have some benefits.
The benefits of imperfect markets include the incentive firms have to come up with product differentiation to be able to attract as many customers as possible and to influence the prices. Imagine how boring it would be if we lived in a perfect market and everyone carried around identical products.
These new products that companies look for are often innovative and fill up huge market gaps. Would it not be preferable to live in an economy where companies are looking for better ways of doing their business so they can acquire new customers?
Imperfect Market - Key takeaways
- If a market doesn’t have the underlying theoretical conditions of a perfectly competitive market, then it is an imperfect market.
- It’s almost impossible to find perfectly competitive markets in the real world as it is extremely difficult to meet all the conditions of such a market.
- An imperfect market contains buyers and sellers who can influence not just the price but also the production of goods and services.
- Sellers in an imperfect market don’t fully disclose all the information about their goods and services.
- It is quite difficult for other firms to join or exit these markets, therefore limiting the number of buyers and sellers.
The types of imperfect markets include monopoly, oligopoly, monopolistic competition, monopsony and oligopsony.
The benefits of imperfect markets include the incentive firms have to come up with product differentiation.
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