In economics, competition is a condition where different economic firms[Note 1] seek to obtain a share of a limited good by varying the elements of the marketing mix: price, product, promotion and place. In classical economic thought, competition causes commercial firms to develop new products, services and technologies, which would give consumers greater selection and better products. The greater selection typically causes lower prices for the products, compared to what the price would be if there was no competition (monopoly) or little competition (oligopoly). The level of competition that exists within the market is dependant on a variety of factors both on the firm/ seller side; the number of firms, barriers to entry, information availability, availability/ accessibility of resources. The number of buyers within the market also factors into competition with each buyer having a willingness to pay, influencing overall demand for the product in the market.
The extent of the competition present within a particular market can measured by; the number of rivals, their similarity of size, and in particular the smaller the share of industry output possessed by the largest firm, the more vigorous competition is likely to be.
Early economic research focused on the difference between price- and non-price-based competition, while modern economic theory has focused on the many-seller limit of general equilibrium.
Perfect Vs imperfect competitionEdit
Neoclassical economic theory places importance in a theoretical market state, in which the firms and market are considered to be in perfect competition. Perfect competition exists when all criteria are met. These criteria include; all firms sell an identical product, all firms are price takers, market share has no influence on price, buyers have complete or "perfect" information, Resources are perfectly mobile and firms can enter or exit the market without cost. Under perfect competition there are many buyers and sellers within the market and prices reflect the overall supply and demand. Another key feature of a perfectly competitive market is the variation in products being sold by firms. The firms within a perfectly competitive market are small, with no larger firms controlling a significant proportion of market share. These firms sell almost identical products with minimal differences or in-cases perfect substitutes to another firms product.
The idea of perfectly competitive markets draws in other neoclassical theories of the buyer and seller. The buyer in a perfectly competitive market identical tastes and preferences with respect to desired product features and characteristics (homogeneous within industries) and also have perfect information. In this type of market buyers are utility maximises, in which they are purchasing a product that maximises their own individual utility that they measure through their preferences. The firm, on the other hand, is aiming to maximise profits acting under the assumption of the criteria for perfect competition.
The firm in a perfectly competitive market will operate in two economic time horizons; the short-run and long-run. In the short-run the firm adjusts its quantity produced according to prices and costs. While in the long run the firm is adjusting its methods of production to ensure they produce at a level where marginal cost equals marginal revenue.
Imperfectly competitive markets are the realistic markets that exist in the economy. Imperfect competition exist when; companies sell different products and services, set their own individual prices, fight for market share and are often protected by barriers to entry and exit, making it harder for new firms to challenge them. An important differentiation from perfect competition is, in markets with imperfect competition, individual buyers and sellers can influence prices and production. Under these circumstances markets move away from the neoclassical economic definition of a perfectly competitive market, as the market fails the criteria and this inevitably leads to opportunities to generate more profit, unlike in a perfect competition environment, where businesses earn just enough to stay afloat. These markets are also defined by the presence of monopolies, oligopolies and externalities within the market.
The measure of competition in accordance to the theory of perfect competition can be measured by either; the extent of influence of the firm's output on price (the elasticity of demand), or the relative excess of price over marginal cost.
Types of imperfect competitionEdit
Monopoly is the opposite to perfect competition. Where perfect competition is defined by many small firms competition for market share in the economy, Monopolies are where one firm holds the entire market share. Monopolies are where rather than the industry or market defining the firms, the single firm defines and dictates the entire market. Monopolies exist where one of more of the criteria fail and make it difficult for new firms to enter the market with minimal costs. Monopoly companies use these barriers to entry to blockade other firms from entering the market to ensure they continue to be the single supplier to the market. A natural monopoly is a type of monopoly that exists due to the high start-up costs or powerful economies of scale of conducting a business in a specific industry. These types of monopolies arise in industries that require unique raw materials, technology, or similar factors to operate. Monopolies can form through both fair and unfair business tactics. These tactics include; collusion, mergers, acquisitions, and hostile takeovers. Collusion might involve two rival competitors conspiring together to gain an unfair market advantage through coordinated price fixing or increases. Natural monopolies are formed through fair business practices where a firm takes advantage of an industry's high barriers. The high barriers to entry are often due to the significant amount of capital or cash needed to purchase fixed assets, which are physical assets a company needs to operate. Natural monopolies are able to continue to operate as they typically can produce and sell at a lower cost to consumers than if there was competition in the market. Monopolies in this case use the resources efficiently in order to provide the product at a lower price. In a monopoly, the marginal profit is equal to the marginal revenue, which is the incremental revenue generated from selling one more unit of the product.
Oligopolies are another form of imperfect competition market structures. An oligopoly is when a small number of firms collude, either explicitly or tacitly, to restrict output and/or fix prices, in order to achieve above normal market returns. Similar factors that allow monopolies to exist also facilitate the formation of oligopolies. These include; high barriers to entry, legal privilege; government outsourcing to a few companies to build public infrastructure (e.g railroads) and access to limited resources, primarily seen with natural resources within a nation. Companies in an oligopoly benefit from price-fixing, setting prices collectively, or under the direction of one firm in the bunch, rather than relying on free-market forces to do so. Oligopolies can form cartels in order to restrict entry of new firms into the market and ensure they hold market share. Governments usually heavily regulate markets that are susceptible to oligopolies to ensure that consumers are not being over charged and competition remains fair within that particular market.
Monopolistic competition characterises an industry in which many firms offer products or services that are similar, but not perfect substitutes. Barriers to entry and exit in a monopolistic competitive industry are low, and the decisions of any one firm do not directly affect those of its competitors. Monopolistic competition exists in-between monopoly and perfect competition, as it combines elements of both market structures. Within monopolistic competition market structures all firms have the same, relatively low degree of market power; they are all price makers. In the long run, demand is highly elastic, meaning that it is sensitive to price changes. In the short run, economic profit is positive, but it approaches zero in the long run. Firms in monopolistic competition tend to advertise heavily. Examples of monopolistic competition include; restaurants, hair salons, clothing, and electronics.
A market share of 50% to over 90%, with no close rival. A high entry barrier. An ability to control pricing, to set systematic discriminatory prices, to influence innovation, and (usually) to earn rates of return well above the competitive rate of return. This is similar to a monopoly, however there are other smaller firms present within the market that make up competition and restrict the ability of the dominant firm to control the entire market and choose their own prices.
Effective competition exists when there are four firms with market share below 40% and flexible pricing. Low entry barriers, little collusion, and low profit rates.
Competitive equilibrium is a concept in which profit-maximising producers and utility-maximising consumers in competitive markets with freely determined prices arrive at an equilibrium price. At this equilibrium price, the quantity supplied is equal to the quantity demanded. This implies that a fair deal has been reached between supplier and buyer, in-which all suppliers have been matched with a buyer that is willing to purchase the exact quantity the supplier is looking to sell and therefore, the market is in equilibrium.
The competitive equilibrium in economic theory is considered to be apart of game theory which deals with decision making of firms in large markets. The overall concept acts as a benchmark for evaluating efficiency in the market and how far off the market is from equilibrium.
The competitive equilibrium has many applications for predicting both the price and total quality in a particular market. It can also be used to estimate the quantity consumed by each individual and the total output of each firm within a market. Furthermore, through using the idea of a competitive equilibrium the effects particular government policies or events can be evaluated and whether they move the market towards or away from the competitive equilibrium.
Role in market successEdit
Competition is generally accepted as an essential component of markets, and results from scarcity—there is never enough to satisfy all conceivable human wants—and occurs "when people strive to meet the criteria that are being used to determine who gets what." In offering goods for exchange, buyers competitively bid to purchase specific quantities of specific goods which are available, or might be available if sellers were to choose to offer such goods. Similarly, sellers bid against other sellers in offering goods on the market, competing for the attention and exchange resources of buyers.:105
The competitive process in a market economy exerts a sort of pressure that tends to move resources to where they are most needed, and to where they can be used most efficiently for the economy as a whole. For the competitive process to work however, it is "important that prices accurately signal costs and benefits." Where externalities occur, or monopolistic or oligopolistic conditions persist, or for the provision of certain goods such as public goods, the pressure of the competitive process is reduced.
In any given market, the power structure will either be in favour of sellers or in favour of buyers. The former case is known as a seller's market; the latter is known as a buyer's market or consumer sovereignty. In either case, the disadvantaged group is known as price-takers and the advantaged group known as price-setters.
Competition bolsters product differentiation as businesses try to innovate and entice consumers to gain a higher market share. It helps in improving the processes and productivity as businesses strive to perform better than competitors with limited resources. The Australian economy thrives on competition as it keeps the prices in check.
In his 1776 The Wealth of Nations, Adam Smith described it as the exercise of allocating productive resources to their most highly valued uses and encouraging efficiency, an explanation that quickly found support among liberal economists opposing the monopolistic practices of mercantilism, the dominant economic philosophy of the time. Smith and other classical economists before Cournot were referring to price and non-price rivalry among producers to sell their goods on best terms by bidding of buyers, not necessarily to a large number of sellers nor to a market in final equilibrium.
Later microeconomic theory distinguished between perfect competition and imperfect competition, concluding that perfect competition is Pareto efficient while imperfect competition is not. Conversely, by Edgeworth's limit theorem, the addition of more firms to an imperfect market will cause the market to tend towards Pareto efficiency.
Appearance in real marketsEdit
Real markets are never perfect. Economists who believe that in perfect competition as a useful approximation to real markets classify markets as ranging from close-to-perfect to very imperfect. Examples of close-to-perfect markets typically include share and foreign exchange markets while the real estate market is typically an example of a very imperfect market. In such markets, the theory of the second best proves that, even if one optimality condition in an economic model cannot be satisfied, the next-best solution can be achieved by changing other variables away from otherwise-optimal values.:217
Within competitive markets, markets are often defined by their sub-sectors, such as the "short term" / "long term", "seasonal" / "summer", or "broad" / "remainder" market. For example, in otherwise competitive market economies, a large majority of the commercial exchanges may be competitively determined by long-term contracts and therefore long-term clearing prices. In such a scenario, a “remainder market” is one where prices are determined by the small part of the market that deals with the availability of goods not cleared via long term transactions. For example, in the sugar industry, about 94-95% of the market clearing price is determined by long-term supply and purchase contracts. The balance of the market (and world sugar prices) are determined by the ad hoc demand for the remainder; quoted prices in the "remainder market" can be significantly higher or lower than the long-term market clearing price. Similarly, in the US real estate housing market, appraisal prices can be determined by both short-term or long-term characteristics, depending on short-term supply and demand factors. This can result in large price variations for a property at one location.
Anti-competitive pressures and practicesEdit
Competition requires the existing of multiple firms, so it duplicates fixed costs. In a small number of goods and services, the resulting cost structure means that producing enough firms to effect competition may itself be inefficient. These situations are known as natural monopolies and are usually publicly provided or tightly regulated.
International competition also differentially affects sectors of national economies. In order to protect political supporters, governments may introduce protectionist measures such as tariffs to reduce competition.
Critiques of Perfect competitionEdit
Economists do not all agree to the practicability of perfect competition. There is debate surround how relevant it is to real world markets and whether it should be a market structure that should be used as a benchmark.
Neoclassical economists believe that perfect competition creates a perfect market structure, with the best possible economic outcomes for both consumers and society, in general, they do not claim that this model is representative of the real world. Neoclassical economists argue that perfect competition can be useful, and most of their analysis stems from its principles.
Economists that are critical of the neoclassical reliance on perfect competition in their economic analysis believe that the assumptions built into the model are so unrealistic that the model cannot produce any meaningful insights. The second line of critic to perfect competition is the argument that it is not even a desirable theoretical outcome. These economists believe that the criteria and outcomes of perfect competition do not achieve a efficient equilibrium in the market and other market structures are better used as a benchmark within the economy.
- This article follows the general economic convention of referring to all actors as firms; examples in include individuals and brands or divisions within the same (legal) firm.
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