In this essay I have analysed the different types of competition and market structures, and linked this to a current world example. I’ve discussed the neo-classical and dynamic approaches to competition and have studied Michael Porter’s Five Force model. Systemic and structural competitiveness has been mentioned, and market economies are examined including technical and allocative efficiency. I have assessed the relationship between competition and the business environment, and finally given personal views and come to an argued conclusion.
Competition is the process by which two or more firms compete in the same market for a larger market share. This rivalry that exists is very beneficial to firms as is leads to increased efficiency and higher output at given cost levels. The amount of competition in a market is measured using concentration ratios (e.g. the five firm concentration ratio).
There are two different types of competition which firms may undertake, price competition and non-price competition. In price competition, firms compete on the basis of price, for example by increasing the price of a good or service, the demand will either increase or decrease accordingly depending on its price elasticity of demand. In non-price competition firms compete in less risky forms of competition other than price, such as advertising and branding. Non-price competition exists in imperfect competition (usually oligopolies).
Imperfect competition occurs in situations when there are a number of competing firms (with market power), but the market is without some or all features of perfect competition. The three types of imperfect competition are duopoly, oligopoly and monopolistic competition. Perfect competition on the other hand exists when a market has a large number of small firms, with no one firm influencing price (firms are price takers, not price makers). These firms all sell identical products, with perfect knowledge of the market, which has no barriers to entry. This represents one end of the competition spectrum (see Appendix 1).
There are two main views to the concept of competition, the dynamic approach and the static approach (Neo-Classical approach). The first is based on the behaviour of firms and their constant interactions with market structure, which involves change and innovation. The second involves classifying market structure, and the type and amount of competition (mainly on number of firms within the market), to determine the firm’s behaviour. This entails looking at traditional models of competition (see Appendix 1). A monopoly is when a market has only one producer. This is the other end of the competition spectrum. The firm in this case is a price maker, as due to little or no competition it can set whatever price it wishes, and is therefore able to achieve supernormal profits (see Appendix 2). However, a disadvantage of a monopoly is that they exploit customers by charging high prices for sometimes poor services, and are also thought to waste resources due to inefficiency.
An example of a company accused of exercising monopoly power is Bill Gates’ Microsoft®. Their Windows software is essential for the use of programs such as Word, and can only be purchased from Microsoft due to exclusive trading rights. The US government is currently investigating Microsoft’s monopoly power, and it is thought that Microsoft will be broken down into smaller companies (deregulation) to promote competition. However, in light of the September 11th US terrorist attacks, the economy is at a very low point, and so the US government may choose to let Microsoft remain as it is, so not to cause more problems for the US economy. In the UK, the Competition Commission would investigate firms with possible monopoly power.
An oligopoly exists when a small number of large firms dominate the market. Competition usually takes form as non-price competition, with differentiated products (substitute products) and barriers to entry. Firms in this type of market are interdependent, there are price makers and price takers, and price may be determined by collusion. Finally, monopolistic competition is when there are many firms selling a slightly differentiated product, allowing consumers to buy from the producer they choose. There is high competition, due to easy entry and exit.
The structure of a particular market lets us know the competitive pressures involved in it. Michael Porter’s Five Forces approach to competitive structure (see Appendix 3) shows the five major fields affecting individual firms and their business environment. These are: intensity of rivalry by existing firms in the industry, threat of entry, threat of substitutes, power of buyers and power of suppliers.
Systemic or structural competitiveness involves four levels of a national economy: the meta level, meso level, macro level and micro level. Overall these refer to infrastructure, business activity and management of enterprises, etc. Factors of importance include legal and economic organisation, competition policy and policies concerning infrastructure.
Market economies (and free market economies) rely on the Market Mechanism . This generally means if demand increases, prices will rise. If supply rises but demand is constant or falling, then price will fall. Fluctuations in demand lead to firms allocating their resources efficiently e.g. a fall in demand may lead to losses and so producers are likely to use their resources for different types of production. There will be many firms, and as price is determined, firms need to be more efficient (e.g. by keeping their production costs low) in order to survive. An advantage of this is that it is automatic, and may lead to technical and allocative efficiency (see Appendix 4), and so therefore leads to greater economic growth. Disadvantages include the cost not reflecting externalities, and monopoly power or market failure may occur.
The business environment of a firm is a combination of factors that can range from as wide as political and legal factors, to as day to day as suppliers and competitors. Competitors and competition is an essential part of the business environment. Effective competition leads to innovation, and most crucially to an efficient business environment. Not only do firms benefit from competition, but the affects are also passed on to consumers in the way of more competitive (reasonable) prices, and higher quality goods and services. On the other hand, a disadvantage to competition may be that smaller firms suffer due to larger firms having more capital, and also benefiting from economies of scale. However, overall the advantages far out-way the disadvantages, and so I conclude that competition is a crucial part of the business environment.