Competition

Examine the concept of competition. Explain how it works in market economies. In what way is it a crucial part of the business environment?

1000 words

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

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