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Competition In Markets Promotes Economic Efficiency

Competition is central to the operation of markets, and fosters innovation, productivity and growth, all of which create wealth and reduce poverty. However, markets do not always work well, and uncompetitive markets are often those that matter most for the poor. This paper outlines the direct and indirect, and often complex, linkages between competition, competition policy, private sector development, growth and poverty reduction. The existence and importance of these linkages is still not sufficiently recognised in the developing world. Introduction:A market with a large number of buyers and sellers, such that no single buyer or seller is able to influence the price or control any other aspect of the market. That is, none of the participants have significant market control. A competitive market achieves efficiency in the allocation of scarce resources if no other market failures are present. A competitive market is a market with a sufficient number of both buyers and sellers such than no one buyer or seller is able to exercise control over the market or the price. Efficiency is achieved because competition among buyers forces buyers to pay their maximum demand price and competition among sellers forces sellers to charge their minimum supply price for the given quantity exchanged. The Invisible Hand of Efficiency A competitive market is efficient because equilibrium is achieved where the demand price and supply are price equal. Competition on the demand side forces buyers to buy a good at the maximum demand price that they are willing and able to pay. The demand price is the value society places on the good produced based on the satisfaction received. Competition on the supply side forces sellers to sell the good at the minimum supply price that they are willing and able to accept. The supply price is the opportunity cost of production, which is the value of goods NOT produced. Equality between the demand and supply prices means that the economy cannot generate any greater satisfaction by producing more of one good and less of another. Competitive markets are the cornerstone of capitalism and a market-oriented economy. They efficiently address the scarcity problem and answer the three questions of allocation automatically (as if guided by an invisible hand) with little or no government intervention. Uncompetitive Markets

The real world contains some markets that come close to this competitive ideal and other markets that fall short. These real world markets can be grouped into three distinct market structures. Monopolistic/Monopsonistic Competition: The most competitive real world markets are termed monopolistic competition or monopsonistic competition, depending on whether the focus is 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, if there is only one seller, or monopsony, if there is only one buyer. Other Market Failures Competitive markets achieve an efficient allocation of resources as long as other market failures are 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 if the supply price does not fully reflect the opportunity cost production. As a result, the market equilibrium does not include all of the information about value and cost needed to achieve efficiency. Public goods are goods characterized by nonrival consumption and the inability to exclude nonpayers. The use of the good by one does not impose a cost on others and no one can be prevented from consuming the good. Imperfect information occurs if buyers or sellers do not know as much about the good as they should for an efficient allocation. In other words, buyers are not aware of the full value they obtain from consuming the good or sellers are not aware of all opportunity cost incurred in production. COMPETITION: In general, the actions of two or more rivals in pursuit of the same objective. In an economic context, the specific objective pursued is usually either selling goods to buyers or buying goods from sellers Competition, as noted by the fourth rule of competition, brings out the best among buyers 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 and forces sellers to supply the most wanted products at the lowest resource cost.

Competition among buyers drives the equilibrium price in a market up to the demand price and forces 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 between the 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 than the demand price, neither of which results in efficiency. Competition by the Numbers The degree of competition in a market is determined by the number of participants. All things being equal, larger numbers lead to greater competition. A market with 10,000 buyers and 10,000 sellers is likely to have greater competition than a market with 10 buyers and 10 sellers. The Few and The Many Playing this numbers game results in two varieties of competition: Competition Among The Few: This form of competition occurs if there are only a handful of participants. Each participant usually knows the other competitors quite well. Many markets operate with competition among the few. In such markets, one seller can gain a competitive advantage 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 Chip Merthington. To win, Edgar only needs to run a little faster than Chip. Edgar does not need to set a world record. Edgar does not need to run his absolute fastest race ever. Edgar only needs to run a 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 even thousands of participants. Each participant is lost among the masses. Competition among the many brings out the best, that is, the most efficient use of resources. In this case, the only way for 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 ten thousand other runners. To win, Edgar needs to do a lot more than run faster than Chip. Edgar needs to run faster than everyone; to be his absolute best. Setting a world record might be needed. Moreover, Edgar cannot count on every other participant in the race to trip and fall.

Market Structures Differing numbers of participants result in a continuum of market structures.

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, the result is monopoly. If there is one participant on the buying side, the result is monopsony. These two 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 of participants, both buyers and sellers. The numbers are so large that no one participant can influence 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 the continuum are markets with large numbers of participants, but fall short of the theoretical perfection. If competition is on the selling side of the market, the result is monopolistic competition. If competition is on the buying side, the result is monopsonistic competition. These market structures are the best real world examples of competition among the many. While they do not achieve efficiency, they often come close. Oligopoly/Oligopsony: Residing near monopoly/monopsony on the continuum are markets with small numbers of participants, but more than one. If competition is on the selling side of the market, 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. They also 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? The Labour Government published its latest White Paper on International Competitiveness in July 2001. The introductory section made it clear that the government regards creating a competitive environment for UK and overseas businesses as a cornerstone of its supply-side economic policies. "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 of production. As such, competition is a central driver for productivity growth in the economy, and hence the UK's international competitiveness" Competitive markets exist when there is genuine choice for consumers in terms of who supplies the goods and services they demand. Competitive markets are characterised by various forms of

price and non-price competition between sellers who are bidding to increase or protect their market share. What are the potential gains from increased market competition? 1.Lower prices for consumers 2.A greater discipline on producers/suppliers to keep their costs down 3.Improvements in technology with positive effects on production methods and costs 4.A greater variety of products (giving more choice) 5.A faster pace of invention and innovation 6.Improvements to the quality of service for consumers 7.Better information for consumers allowing people to make more informed choices

The overall impact of increased competition should be an improvement in economic welfare.

Price and Non Price Competition Firms compete for market share and the demand from consumers in lots of ways. We make an important distinction between price competition and non-price competition. Price competition can involve discounting the price of a product to increase demand. Non-price competition focuses on other strategies for increasing market share. Consider the example of the UK supermarket sector where non-price competition has become important 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)

Innovative use of technology for shoppers including self-scanning and internet shopping services Opening Up Markets Liberalisation Creating more competition in markets involves breaking down the barriers to competition that invariably exist in each industry. Perfectly contestable markets are rare. One of the key strategies of governments over the last twenty years has been to liberalise markets by cutting the statutory monopoly power of businesses. Two good examples of this have been in gas and electricity supply, and also telecommunications. Energy market liberalization Liberalisation of energy markets has led to lower costs through increased efficiency and lower prices for consumers. The UK gas and electricity markets are already fully liberalised, with all types of customer able to choose their own supplier. For example: More than 30% of domestic gas customers and 25% of electricity customers have switched suppliers and domestic electricity prices have fallen as markets have opened up. Telecommunications UK consumers have benefited from rapid price falls as a result of the opening up of the UK market in telecoms: Mobile phone prices have fallen by 20% in 18 months from the beginning of 1999. And, the cost of international calls has fallen dramatically over the past decade. Opening Up Markets (2) - Tougher Regulation Privatisation and liberalisation of markets has opened many sectors to greater competition. A second strand to current government policy is to toughen up the regulation of markets through competition policy. The Competition Act 1998 prohibits cartels and other anti-competitive agreements and other abuses of dominant market position. Firms which breach the prohibitions in the Competition Act can be subject to penalties of up to 10% of UK turnover in the relevant market, for up to three years of an infringement. They also face the prospect of actions for damages against them by third parties that have been harmed by their illegal acts. The Office of Fair Trading is now responsible for taking decisions on day-to-day competition cases. Competition policy and economic growth How does competition policy promote economic growth? First, competition results in goods and services being provided to consumers at a lower price and so more is consumed and produced. Most producers are also consumers. To the extent that the

pay higher prices for their inputs than foreign competitors because of lack of competition or anticompetitive practices in those markets, firms will be less competitive. Second, competition policy, properly implemented, promotes efficiency and productivity. Firms faced with vigorous competition are continually pressed to become more internally efficient and more productive. Competition compels managers to reduce waste, improve the technical efficiency of production, abandon outdated production techniques and operations and invest in new 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 lost competitiveness. The competition for capital and other resources by firms throughout the economy leads to money and resources flowing away from weak uncompetitive sectors towards the more competitive sectors. Hence competition directs resources to its most efficient use and leads to the closure of inefficient firms and the freeing up resources for more productive uses. Competition policy Competition policy can be defined generally as a set of policies and instruments that are intended to encourage competition in markets and to encourage the allocative efficiency that generally accompanies competition. Competition policy broadly encompasses efforts at: - Preventing cartels or other joint efforts at price-fixing (or market allocation, or agreements on product attributes); - Preventing mergers where the consequences would be a significant lessening of competition (or a strengthening of whatever market power may already be present); and - Preventing unilateral actions by a seller where the consequence would be a significant enhancement of the seller's market power The main Aim of Competetion policy:The aim of competition policy is promote competition; make markets work better and contribute towards increased efficiency and competitiveness of the UK economy within the European Union 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.


The growth of economy is contributed by competitive market but not with monopoly market or oligopoly market. Because monopoly and oligopoly encourages the sellers where as competitive market encourages the consumers and buyers with competitive price which is healthy for the economy. Barriers to competition are pervasive and harm innovation, productivity and growth in developing countries. Fair competition matters, both for economic growth and for reducing poverty. Helping markets to work better, by removing unnecessary distortions to competition, can lead to significant reforms of the business environment. These factors make competition policy and law a priority area for reform in developing countries. There is a need for a wider understanding at policy levels in government, in the business sector and by consumers, of the beneficial 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 encourage both domestic investment and FDI, because it encourages investor confidence28 by setting a consistent framework within which the business sector operates. An effective competition policy allows innovative new entrants an important role in the development process, and promotes growth. More effective competition reduces opportunities for corruption and rent seeking, and creates more space for entrepreneurs and small and medium sized-enterprises. Having a good law is not enough. The introduction of a competition law needs appropriate supporting policies, and effective enforcement. Governments must show support for market economies and must recognise adequately the impact of other legislation and regulations on competition. The design of an appropriate national competition policy must keep local realities in mind, and give sufficient weight to governance capabilities and institutions and to political realities 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 the background to decisions by government, firms and consumers. Civil society and a vigorous consumer movement in particular, can play a constructive and valuable role in the development of a culture of competition. Vested interests that oppose reforms and fair competition have to be overcome. An open media and an informed judiciary are needed if competition policy and law are to be fully effective. Above all, politicians must be committed to wanting to make markets work well, to ensuring that the governments responsibilities to markets are well understood and to help build the technical capacity needed for this task.