In economic theory, imperfect competition is a type of market structure showing some but not all features of competitive markets.
Forms of imperfect competition include:
- Monopolistic competition: A situation in which many firms with slightly different products compete. Production costs are above what may be achieved by perfectly competitive firms, but society benefits from the product differentiation.
- Monopoly: A firm with no competitors in its industry. A monopoly firm produces less output, has higher costs, and sells its output for a higher price than it would if constrained by competition. These negative outcomes usually generate government regulation.
- Oligopoly: An industry with only a few firms. If they collude, they form a cartel to reduce output and drive up profits the way a monopoly does.
- Duopoly: A special form of Oligopoly, with only two firms in an industry.
- Monopsony: A market with a single buyer and many sellers.
- Oligopsony: A market with a few buyers and many sellers.
Monopolies are not often found in practice, the more usual market format is oligopoly: several firms, each of whom is big enough that a change in their price will affect the price of the other firms, but none with an unchallenged monopoly. When looking at oligopolies the problem of interdependence arises.
Interdependence means that the firms will, when setting their prices, consider the effect this price will have on the actions of both consumers and competitors. For their part, the competitors will consider their expectations of the firm’s response to any action they may take in return. Thus, there is a complex game with each side “trying to second guess each others’ strategies.”The Monopolistic Competition model is used because its simplicity allows the examination of one type of oligopoly while avoiding the issue of interdependence.