We all have heard the word ‘market’ in our day-to-day lives. Usually, after hearing the word ‘market’, the first thing that comes to our mind is a place where we can buy commodities, like a fruit market. But, the market is a wider concept than this. A market is not only a physical place but is an arrangement or a system where buyers and sellers come in contact with each other to settle buying and selling of goods.
An example will help us understand the concept better:
Assume you are a buyer and you go to a trade fair, where you meet many sellers who are ready to sell (i.e. fulfill your demand). This whole system of buyers meeting the seller at a place and settling the buying and selling of goods is known as a Market Structure.
You can also say that it is a place where demand and supply are fulfilled. Now that we know the market we can learn about two forms of market: perfect competition and imperfect competition.
In this form of market, there are a large number of sellers and a large number of buyers of the commodity. This market deals with homogeneous products (physically identical goods). The price of the goods is determined by the market forces of supply and demand. No individual buyer or seller has any control over the price of the goods. This is because the market deals in homogeneous goods i.e. the price and the features of the good are the same.
Buyers and sellers have complete knowledge. They are fully aware of the price in the market. There is freedom of entry and exit in this form of market. Here comes the role of short-term and long-term. A company can enter and exit this market only in the long term and not in the short term, as the short term is too short for any company to enter or exit the market.
The factors of production are perfectly mobile. Factors of production include Land, Labour, Capital and Entrepreneurship.
Firms under Perfect Competition are Price Takers, not Price Makers. This means that the firm’s price is decided by market supply and demand and the firm has no hold on the commodity's price. Therefore, this market is formed when there is a large number of buyers and sellers dealing with inhomogeneous products with freedom of entry and exit and earning normal profits in the long term with perfect mobility of factors of production, which makes a firm a price taker.
An example of Perfect Competition is agriculture, where products are similar, be it onions, carrots, beetroots, grain or potatoes, where many farmers can produce and sell them
Imperfect competition, which is also called monopolistic competition, is a form of market in which there are many buyers and sellers of the product, but the product of each seller is different from that of the other. Thus, there are many sellers selling differentiated products. Product differentiation is generally promoted through a trademark or brand name.
For example, firms are producing different brands of cereals, like Kellogg’s, Nestlé and Bagrry's.
Some may even say that monopolistic competition is a middle ground between perfect competition and monopoly. It includes the features of both markets. A trademark and a brand name give some monopoly power to the firms. Different firms often charge different prices for their product.
In other words, each firm tends to exercise some control over price. On the other hand, since many firms are producing a commodity (like cereals), there is competition in the market. None of the firms can exercise full control over the price of the product. Thus, we can say that a firm under monopolistic competition exercises only partial control over price.
Some other samples of industries with market structures like monopolistic competition include restaurants, toothpaste, clothing shoes and repair industries in large cities. These are industries where differentiation is possible.
The features of imperfect competition include:
- Many Firms: As under perfect competition, there is a large number of buyers and sellers. Also, the size of each firm is small. Each firm features a limited share of the market.
- Product Differentiation: The product they deal in is differentiated. Product differentiation is generally done through a trademark or brand name. Think about toothpaste brands like Colgate, Pepsodent and Oral-B.
- Freedom of Entry and Exit: Freedom of entry and exit prevails but there is not complete freedom as, in the industry, the products made by the existing firms can be patented and the forthcoming firm cannot produce identical products.
- Imperfect Information: The sellers and buyers lack perfect knowledge about the market because of product differentiation. This leads to consumers’ exploitation, as they can be charged higher prices for low-quality products.
- Selling Cost: Selling cost is a major aspect of this form of market. Being the market dealing in differentiated products, the firm needs to incur selling costs (advertisement/publicity) to increase its market share.
- Market Competition: Non-price competition prevails in a monopolistic competitive market, where the firms try to avoid price wars and tend to increase their market share by promoting its product. Strategies include celebrity endorsements and after-sale service for durable goods.
Overall, the firms in the monopolistic form of the market deal in differentiated products, and to gain market share, incur selling costs and avoid a price war.
The Importance of Product Differentiation In Imperfect Competition
- It allows a firm partial control over the price of its product. Partial control over the price leads to partial monopoly power.
- The availability of close substitutes increases the consumer’s choice and increases their welfare.
- Product differentiation may be fake or real. In case it is fake, it leads to the exploitation of consumers through fake publicity of the product.
And that’s the distinction between perfect and imperfect competition.