Competetion in market promotes economic efficiency


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Competetion in market promotes economic efficiency

  1. 1. Competition In Markets Promotes Economic Efficiency“Competition is central to the operation of markets, and fosters innovation, productivityand growth, all of which create wealth and reduce poverty. However, markets do notalways work well, and uncompetitive markets are often those that matter most for thepoor. This paper outlines the direct and indirect, and often complex, linkages betweencompetition, competition policy, private sector development, growth and povertyreduction. The existence and importance of these linkages is still not sufficiently recognisedin the developing world.”Introduction:-A market with a large number of buyers and sellers, such that no single buyer or seller is able toinfluence the price or control any other aspect of the market. That is, none of the participantshave significant market control. A competitive market achieves efficiency in the allocation ofscarce resources if no other market failures are present.A competitive market is a market with a sufficient number of both buyers and sellers such thanno one buyer or seller is able to exercise control over the market or the price. Efficiency isachieved because competition among buyers forces buyers to pay their maximum demand priceand competition among sellers forces sellers to charge their minimum supply price for the givenquantity exchanged.The Invisible Hand of EfficiencyA competitive market is efficient because equilibrium is achieved where the demand price andsupply are price equal.Competition on the demand side forces buyers to buy a good at the maximum demand price thatthey are willing and able to pay. The demand price is the value society places on the goodproduced based on the satisfaction received.Competition on the supply side forces sellers to sell the good at the minimum supply price thatthey are willing and able to accept. The supply price is the opportunity cost of production, whichis the value of goods NOT produced.Equality between the demand and supply prices means that the economy cannot generate anygreater satisfaction by producing more of one good and less of another.Competitive markets are the cornerstone of capitalism and a market-oriented economy. Theyefficiently address the scarcity problem and answer the three questions of allocationautomatically (as if guided by an invisible hand) with little or no government intervention.Uncompetitive Markets
  2. 2. The real world contains some markets that come close to this competitive ideal and othermarkets that fall short. These real world markets can be grouped into three distinct marketstructures.Monopolistic/Monopsonistic Competition: The most competitive real world markets aretermed monopolistic competition or monopsonistic competition, depending on whether the focusis on the sellers (monopolistic) or the buyers (monopsonistic).Oligopoly/Oligopsony: Real world markets with a modest amount of competition, but not a lot,are termed oligopoly or oligopsony, depending on whether the focus is on the sellers (oligopoly)or the buyers (oligopsony).Monopoly/Monopsony: Real world markets that have no competition are termed monopoly, ifthere is only one seller, or monopsony, if there is only one buyer.Other Market FailuresCompetitive markets achieve an efficient allocation of resources as long as other market failuresare not present. The lack of competition, also termed market control, is one key market failure.Three noted market failures are externalities, public goods, and imperfect information.Externalities arise if the demand price does not fully reflect the value generated by the good or ifthe supply price does not fully reflect the opportunity cost production. As a result, the marketequilibrium does not include all of the information about value and cost needed to achieveefficiency.Public goods are goods characterized by nonrival consumption and the inability to excludenonpayers. The use of the good by one does not impose a cost on others and no one can beprevented from consuming the good.Imperfect information occurs if buyers or sellers do not know as much about the good as theyshould for an efficient allocation. In other words, buyers are not aware of the full value theyobtain from consuming the good or sellers are not aware of all opportunity cost incurred inproduction.COMPETITION:In general, the actions of two or more rivals in pursuit of the same objective. In an economiccontext, the specific objective pursued is usually either selling goods to buyers or buying goodsfrom sellers Competition, as noted by the fourth rule of competition, brings out the best amongbuyers and sellers, that is, it results in an efficient use of resources.Competition among sellers drives the equilibrium price in a market down to the supply price andforces sellers to supply the most wanted products at the lowest resource cost.
  3. 3. Competition among buyers drives the equilibrium price in a market up to the demand price andforces buyers to spend their incomes on the most satisfying goods.Competition on both the demand-side and supply-side of the market results in equality betweenthe demand price and the supply price, which is essential for efficiency.Without competition, sellers can charge more than the supply price or buyers can pay less thanthe demand price, neither of which results in efficiency.Competition by the NumbersThe degree of competition in a market is determined by the number of participants. All thingsbeing equal, larger numbers lead to greater competition. A market with 10,000 buyers and10,000 sellers is likely to have greater competition than a market with 10 buyers and 10 sellers.The Few and The ManyPlaying this numbers game results in two varieties of competition:Competition Among The Few: This form of competition occurs if there are only a handful ofparticipants. Each participant usually knows the other competitors quite well. Many marketsoperate with competition among the few. In such markets, one seller can gain a competitiveadvantage by offering a product that is just a little better than the others--not the best product,only a little better product. Such competition seldom leads to an efficient use of resources.Competition among the few is like a race between Edgar Millbottom and his buddy ChipMerthington. To win, Edgar only needs to run a little faster than Chip. Edgar does not need to seta world record. Edgar does not need to run his absolute fastest race ever. Edgar only needs to runa little faster than Chip. In fact, if Chip trips and falls, then Edgar wins easily.Competition Among The Many: This form of competition occurs if there are hundreds or eventhousands of participants. Each participant is lost among the masses. Competition among themany brings out the best, that is, the most efficient use of resources. In this case, the only wayfor a seller to gain a competitive advantage is to produce the best possible product.Competition among the many is like a race among Edgar Millbottom, Chip Merthington, and tenthousand other runners. To win, Edgar needs to do a lot more than run faster than Chip. Edgarneeds to run faster than everyone; to be his absolute best. Setting a world record might beneeded. Moreover, Edgar cannot count on every other participant in the race to trip and fall.Market StructuresDiffering numbers of participants result in a continuum of market structures.
  4. 4. Monopoly/Monopsony: One end of the continuum are markets with only one participant,meaning there is no competition. If there is one participant on the selling side of the market, theresult is monopoly. If there is one participant on the buying side, the result is monopsony. Thesetwo market structures are the antithesis of competition. There is no competition.Perfect Competition: At the other end of the continuum are markets with large numbers ofparticipants, both buyers and sellers. The numbers are so large that no one participant caninfluence the market price in any way. Perfect competition achieves efficiency as the theoretical,ideological benchmark market structure for competition among the many.Monopolistic/Monopsonistic Competition: Residing close to perfect competition on thecontinuum are markets with large numbers of participants, but fall short of the theoreticalperfection. If competition is on the selling side of the market, the result is monopolisticcompetition. If competition is on the buying side, the result is monopsonistic competition. Thesemarket structures are the best real world examples of competition among the many. While theydo not achieve efficiency, they often come close.Oligopoly/Oligopsony: Residing near monopoly/monopsony on the continuum are markets withsmall numbers of participants, but more than one. If competition is on the selling side of themarket, the result is oligopoly. If competition is on the buying side, the result is oligopsony.These market structures are the ones most likely to practice competition among the few. Theyalso tend to have numerous efficiency problems.Benefits of competitive markets:-Why are competitive markets seen as beneficial for consumers and the economy as a whole? TheLabour Government published its latest White Paper on International Competitiveness in July2001. The introductory section made it clear that the government regards creating a competitiveenvironment for UK and overseas businesses as a cornerstone of its supply-side economicpolicies."Vigorous competition between firms is the lifeblood of strong and effective markets.Competition helps consumers get a good deal. It encourages firms to innovate by reducing slack,putting downward pressure on costs and providing incentives for the efficient organisation ofproduction. As such, competition is a central driver for productivity growth in the economy, andhence the UKs international competitiveness"Competitive markets exist when there is genuine choice for consumers in terms of who suppliesthe goods and services they demand. Competitive markets are characterised by various forms of
  5. 5. price and non-price competition between sellers who are bidding to increase or protect theirmarket share.What are the potential gains from increased market competition?1.Lower prices for consumers2.A greater discipline on producers/suppliers to keep their costs down3.Improvements in technology – with positive effects on production methods and costs4.A greater variety of products (giving more choice)5.A faster pace of invention and innovation6.Improvements to the quality of service for consumers7.Better information for consumers allowing people to make more informed choicesThe overall impact of increased competition should be an improvement in economic welfare.Price and Non Price CompetitionFirms compete for market share and the demand from consumers in lots of ways. We make animportant distinction between price competition and non-price competition. Price competitioncan involve discounting the price of a product to increase demand. Non-price competitionfocuses on other strategies for increasing market share.Consider the example of the UK supermarket sector where non-price competition has becomeimportant in the battle for sales•Traditional advertising / marketing•Store Loyalty cards•Banking and other Services (including travel insurance)•In-store chemists and post offices•Home delivery systems•Discounted petrol at hypermarkets•Extension of opening hours (24 hour shopping)
  6. 6. •Innovative use of technology for shoppers including self-scanning and internet shoppingservicesOpening Up Markets – LiberalisationCreating more competition in markets involves breaking down the barriers to competition thatinvariably exist in each industry. Perfectly contestable markets are rare. One of the key strategiesof governments over the last twenty years has been to liberalise markets by cutting the statutorymonopoly power of businesses. Two good examples of this have been in gas and electricitysupply, and also telecommunications.Energy market liberalizationLiberalisation of energy markets has led to lower costs through increased efficiency and lowerprices for consumers. The UK gas and electricity markets are already fully liberalised, with alltypes of customer able to choose their own supplier. For example: More than 30% of domesticgas customers and 25% of electricity customers have switched suppliers and domestic electricityprices have fallen as markets have opened up.TelecommunicationsUK consumers have benefited from rapid price falls as a result of the opening up of the UKmarket in telecoms: Mobile phone prices have fallen by 20% in 18 months from the beginning of1999. And, the cost of international calls has fallen dramatically over the past decade.Opening Up Markets (2) - Tougher RegulationPrivatisation and liberalisation of markets has opened many sectors to greater competition. Asecond strand to current government policy is to toughen up the regulation of markets throughcompetition policy.The Competition Act 1998 prohibits cartels and other anti-competitive agreements and otherabuses of dominant market position. Firms which breach the prohibitions in the Competition Actcan be subject to penalties of up to 10% of UK turnover in the relevant market, for up to threeyears of an infringement. They also face the prospect of actions for damages against them bythird parties that have been harmed by their illegal acts. The Office of Fair Trading is nowresponsible for taking decisions on day-to-day competition cases.Competition policy and economic growthHow does competition policy promote economic growth?First, competition results in goods and services being provided toconsumers at a lower price andso more is consumed and produced. Mostproducers are also consumers. To the extent that the
  7. 7. pay higher pricesfor their inputs than foreign competitors because of lack of competition oranti-competitive practices in those markets, firms will be less competitive.Second, competition policy, properly implemented, promotes efficiency andproductivity. Firmsfaced with vigorous competition are continually pressedto become more internally efficient andmore productive. Competitioncompels managers to reduce waste, improve the technicalefficiency ofproduction, abandon outdated production techniques and operations and invest innew technologies.Third, competition fosters innovation – firms who do not innovate are left behind.Fourth, competition forces restructuring in sectors, at the appropriate time,that have lostcompetitiveness. The competition for capital and otherresources by firms throughout theeconomy leads to money and resourcesflowing away from weak uncompetitive sectors towardsthe morecompetitive sectors. Hence competition directs resources to its mostefficient use andleads to the closure of inefficient firms and the freeing upresources for more productive uses.Competition policyCompetition policy can be defined generally as a set of policies and instruments that areintendedto encourage competition in markets and to encourage the allocative efficiency thatgenerallyaccompanies competition. Competition policy broadly encompasses efforts at:- Preventing cartels or other joint efforts at price-fixing (or market allocation, or agreementsonproduct attributes);- Preventing mergers where the consequences would be a significant lessening ofcompetition (ora strengthening of whatever market power may already be present); and- Preventing unilateral actions by a seller where the consequence would be asignificantenhancement of the sellers market powerThe main Aim of Competetion policy:-The aim of competition policy is promote competition; make markets work better and contributetowards increased efficiency and competitiveness of the UK economy within the EuropeanUnion single market. Competition policy aims to ensure:• Wider consumer choice in markets for goods and services.• Technological innovation which promotes gains in dynamic efficiency.• Effective price competition between suppliers.CONCLUSION
  8. 8. The growth of economy is contributed by competitive market but not with monopoly market oroligopoly market. Because monopoly and oligopoly encourages the sellers where as competitivemarket encourages the consumers and buyers with competitive price which is healthy for theeconomy.Barriers to competition are pervasive and harm innovation, productivity and growth –in developing countries. Fair competition matters, both for economic growth and for reducingpoverty. Helping markets to work better, by removing unnecessary distortions to competition,can lead to significant reforms of the business environment. These factors make competitionpolicy and law a priority area for reform in developing countries. There is a need for a widerunderstanding at policy levels in government, in the business sector and by consumers, of thebeneficial impact of effective competition and of competition policy on an economy.Where competition policy is part of an open and well-regulated economy, it can help encourageboth domestic investment and FDI, because it encourages investor confidence28 by setting aconsistent framework within which the business sector operates. An effective competition policyallows innovative new entrants an important role in the development process, and promotesgrowth. More effective competition reduces opportunities for corruption and rent seeking, andcreates more space for entrepreneurs and small and medium sized-enterprises. Having a good law is not enough. The introduction of a competition law needs appropriatesupporting policies, and effective enforcement. Governments must show support for marketeconomies and must recognise adequately the impact of other legislation and regulations oncompetition. The design of an appropriate national competition policy must keep local realities inmind, and give sufficient weight to governance capabilities and institutions and to politicalrealities that will often include the presence of small and frequently vulnerable domestic markets. To be fully effective, a competition policy must be supported by a „culture of competition‟ ,where the objectives of competition are widely understood and form a natural part of thebackground to decisions by government, firms and consumers. Civil society and a vigorousconsumer movement in particular, can play a constructive and valuable role in the developmentof a culture of competition. Vested interests that oppose reforms and fair competition have to beovercome. An open media and an informed judiciary are needed if competition policy and laware to be fully effective. Above all, politicians must be committed to wanting to make marketswork well, to ensuring that the government‟ s responsibilities to markets are well understood andto help build the technical capacity needed for this task.