However, there are certain problems.
- Businesses only make what are known as "normal profits". Normal profits are relatively modest. They are only just enough to prevent new businesses being attracted to the market and existing businesses leaving the market. Businesses operating under normal competition making larger than normal profits would quickly see these profits eroded by the entrance of new businesses into the market forcing prices, and therefore profits, down.
- Businesses operating under perfect competition are not able to control their prices. This is because of the competitiveness of the markets in which they operate. Such businesses have little control over their own destinies. They are completely governed by market conditions.
It is for the above reasons that businesses prefer to operate in conditions that are less competitive than perfect competition. Wherever possible, the majority of businesses attempt to exert some control over the markets in which they operate.
Within imperfect competition, there are three types of competition. These are oligopoly, monopolistic, and monopoly.
Oligopoly
When there are many firms, but only a few dominate the market, oligopoly is said to exist. Examples include the markets for petrol, beer, detergents, paint and sweets. The majority of businesses in the UK operate under this type of competition.
Under oligopoly, each firm will have a differentiated product, often with a strong brand identity. Several brands may be competing in the same market. Brand loyalty amongst customers is encouraged by advertising and promotion. Firms in such markets are often said to compete in the form of non-price competition. Prices are often stable for long periods, disturbed only by short price wars.
Although brand loyalty does allow some price control, businesses often "follow" the price of the leader. This means that they tend to be interdependent. In extreme acses firms might even "fix" a price. Sometimes this is illegal and may be called a restrictive trade practice.
Barriers to entry exist. If it was as easy for new firms to enter the industry, they would set up and take the market share of the few large producers. Examples of barriers to entry might be:
- legal restrictions, such as patents which prevent other businesses copying products for a period of time;
- high start up costs, such as the cost of steel manufacturing;
- the promotion or advertising required, for example, in the tobacco or soap powder industries;
collusion between businesses in cartels, which act together to prevent new entrants.
Monopolistic
Monopolistic competition exists where a large number of relatively small firms compete in an industry. There are few barriers to entry, so that it is fairly easy for firms to set up and to leave these markets. Firms will also have perfect knowledge of the market.
Each firm has a product that is differentiated from the others. This is achieved through branding, when a product is given an identity of its own. A business will face competition from a wide range of other firms competing in the same market with simliar, but differentiated, products.
Firms operating under these conditions are not price takers but they will only have a limited degree of control over the prices they charge. There are few markets of this kind in the UK. Two examples include legal services and the manufacture of certain types of clothing.
Monopoly
Monopoly occurs when one business has total control over the market and is the only seller of the product. This pure monopoly should not be confused with a legal monopoly, which occurs in the UK when a firm controls 25 per cent or more of the market.
Monopolists are likely to erect barriers to prevent others from entering the market. They will also exert a strong influence on the price which they charge for their product. However, because monopolists are the only supplier of a product, it does not mean that they can charge whatever they want. If they raise a price a great deal demand will fall to some extent. Because of the influence monopolists have on their price, they are often called price makers.
From a business's point of view, monopoly has certain advantages and problems. To some extent these are the inverse of the benefit and problems of perfect competition. For example, monopolies tend to make "abnormal" profits compared to competitive businesses. However, there may be little or no incentive to innovate for a large business if it faces a lack of competition. It may therefore be less efficient and profitable than it is capable. This could lead to bereaucracy, inefficient mangament and a lower dividend for shareholders.
