Imperfect market definition

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What is an Imperfect Market?

An imperfect market is an environment in which all parties do not have complete information, and in which participants can influence prices. All markets are imperfect to some degree. The usual effect of an imperfect market is that astute traders take advantage of the situation. This may be monopoly owners who profit from excessively high prices, investors who buy or sell securities based on insider information, or buyers who engage in arbitrage to buy goods at artificially low prices and sell them elsewhere at higher prices.

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Examples of Imperfect Markets

Here are several examples of imperfect markets:

  • Monopolies and oligopolies. An organization could have established a monopoly, so it can charge prices that would normally be considered too high. The same situation arises in an oligopoly, where there are so few competitors that there is no point in competing on price. For example a water company has a monopoly over the households and businesses to which it provides water.

  • State intervention. Governments may intervene in a market, usually to set prices below the actual market level (such as by subsidizing the price of oil). When this happens, an excessive quantity is purchased. The reverse situation can also occur, where a government imposes such high regulatory barriers that few companies are allowed to compete (see the preceding monopoly and oligopoly discussion). For example, when a government imposes a hefty tariff on imported electric cars, this shifts consumer purchases towards the electric cars produced by domestic manufacturers - even if they are relatively expensive.

  • Stock market. The stock market can be considered an imperfect market, since investors do not always have immediate access to the most recent information about the issuers of securities. For example, a corporate insider could leak information to a friend about a possible acquisition, allowing the friend to profit from a subsequent run-up in the stock price.

  • Differing product features. An imperfect market can exist when competing products contain different features. When this is the case, buyers have a difficult time comparing the products, and so may pay too much for them.