COMPETITION AND MARKET TYPES 1 COMPETITION AND MARKET

COMPETITION AND MARKET TYPES 1

COMPETITION AND MARKET TYPES • In the previous chapter we examined the working of the market mechanism in a simple and idealized perfectly competitive market model. • In fact, there are different types of real markets. 2

COMPETITION AND MARKET TYPES • Markets are classified by the degree and the extent of competition that they exhibit. • Here we will classify markets simply as – perfectly competitive markets – and monopolistic markets. 3

COMPETITION AND MARKET TYPES • In perfect competition there are many sellers and many buyers of the same good. • No individual buyer or seller has market power to influence the market price. • In monopolistic markets, however, individual seller has the market power; it can influence the market price. 4

COMPETITION: HOW? 5

COMPETITION: HOW? • In any economy there are many private companies. • The main purpose of the private companies is to maximize their profits. • To achieve this purpose, they should operate efficiently. 6

COMPETITION: HOW? • But the efficiency and profitability of any firm depends not only on its own policies and operations but also on the behaviors of their rivals. • Thus, they also have to consider the economic threat posed by competing firms. 7

COMPETITION: HOW? • Competition opens new opportunities for individual firms: they can expand revenues and profits by winning a larger share of sales from competitors. 8

COMPETITION: HOW? • But competition also poses new challenges since other companies are also trying to capture more market share at the expense of their competitors. 9

COMPETITION: HOW? • If a company can’t stand up to the competition, it won’t make quite as much profit as other companies, and eventually it will be destroyed by these competing firms producing better products at lower cost. 10

COMPETITION: HOW? • Most of the company behaviors are motivated, and indeed enforced, by competitive pressures from rival companies. 11

COMPETITION: HOW? • Competitive pressure leads companies to do dramatic, innovative, often painful and even destructive things; not solely because their owners and executives are greedy, but because they desperately want to stay in business. 12

COMPETITION: HOW? • Each firm’s owners want to see their own firm succeed and the other firms fail. • Companies confront each other in the three distinct places: – product market, – labor market, – and financial market. 13

COMPETITION: HOW? • The most important confrontation is in the product market. • Here each company must convince customers that its product offers superior quality for a lower price. • If they can’t do this, they won’t sell the products they have produced, and will never earn a profit. 14

COMPETITION: HOW? • Companies also compete in the labor market. • And a company’s ability to employ and discipline its workers affects its overall performance. 15

COMPETITION: HOW? • Finally, companies must also compete for cheap financial capital in financial market because they finance their operations not only by their equity capital, but they also borrow from financial market. 16

PERFECT COMPETITION VERSUS REAL-WORLD COMPETITION 17

PERFECT COMPETITION VERSUS REAL-WORLD COMPETITION • In perfect competition, individual firms are tiny. • They cannot grow bigger because it is assumed that their average production costs rise as they grow. • This assumption may be valid for only a small part of markets. 18

PERFECT COMPETITION VERSUS REAL-WORLD COMPETITION • In most markets, larger companies have clear cost advantages in producing most goods and services. • As the volume of output grows, average costs per unit fall dramatically. • This is a powerful stimulus for companies to grow. 19

PERFECT COMPETITION VERSUS REAL-WORLD COMPETITION • The decline in the average production cost in an industry as the volume of output grows is called economies of scale. 20

PERFECT COMPETITION VERSUS REAL-WORLD COMPETITION • In most cases, there is room only for just a few manufacturers because of economies of scale. • Economies of scale explains – why small companies cannot compete in most industries, – and why companies always try to boost sales and make better use of fixed capacity. 21

Perfect Competition 22

Perfect Competition • The main assumptions of perfect competition: a) Firms produce completely identical products, so that consumers can’t tell the difference between one variety of a product and another. 23

Perfect Competition b) Market players have perfect information about all product qualities and prices. So, there are no search or transaction costs; neither risk nor uncertainty. 24

Perfect Competition c) There is free entry and free exit. There are no barriers to joining or leaving an industry. 25

Perfect Competition d) As any firm is very small in relation to the whole market, it has no say in the price it charges. The price which faces the firm is given by the market. Individual producers are powerless; they cannot influence market trends. And they cannot try to anticipate or respond to the behavior of their competitors. 26

Perfect Competition • In this theory, competition is so intense and anonymous that it eliminates super profits. • Prices are driven to such a low level that companies can only just cover the costs of production, and earn only normal profits, in the long run. 27

Perfect Competition • The reason is that the guiding light of high profit attracts other firms into the market and encourages existing firms to build bigger plants. • With the increasing capacity, the overall market supply would increase. 28

Perfect Competition • If industrial supply increases more than market demand, price falls. • The process comes to rest when all firms make normal profits, until there is a change in the market affecting either price or costs. 29

Perfect Competition • On the other hand, if firms make losses, they will leave the industry. • The reduction of firms in the industry will decrease the market supply and this will continue until prices in the industry have risen to the level where the remaining firms can make a normal profit. 30

Perfect Competition • So, firms will move into, or leave the market, until making only a normal profit. 31

Monopolistic Markets 32

Monopolistic Markets • In most of the real markets, competition is very different from perfect competition. • The larger a company, in general, the lower its production costs become thanks to economies of scale. • The fact that companies are very large in no way implies, however, that competition has become less intense. 33

Monopolistic Markets • The incredible resources, technology, and managerial abilities that large corporations have at their disposal allow them to compete in many ways and places. • Competition is fierce. 34

Monopolistic Markets • In contrast to perfect competition, monopolistic firms can make supernormal profits which continue in the long run, because no other firm can enter to share existing profits. 35

Monopolistic Markets • Perfectly competitive model implies equal market power among sellers and buyers. • But, in real life, one side of the market, sellers or buyers, may have the upper hand. 36

Monopolistic Markets • Indeed, supply and demand are not separate in markets where for example, the impact of advertising is engineered by large corporate suppliers who can affect demand. 37

Monopolistic Markets • Moreover, within groups of buyers or sellers, some may have greater income and power. • The market does not operate by one person one vote principle. • Spending and decision-making power may be very unequally divided. 38

Monopolistic Markets • In perfect competition there are no discussion of risks and uncertainties faced by real-world actors. • Buyers and sellers have no long-term commitment to each other in the market. • People can switch their exchange transactions with ease. 39

Monopolistic Markets • Whatever the good, all products are homogenous; and whoever the buyer or seller, all people are assumed to be the same for the purpose of market trading. • There is no place for trust, hope or doubt. 40

Monopolistic Markets • In actual markets, however, the determinants of supply and demand are fashioned in part by society’s – institutional characteristics, – past evolutionary path – and social norms. 41

Monopolistic Markets • In perfect competition prices are flexible; any change in demand or in supply or both influences the market price instantaneously. • Monopolistic markets, in contrast, are characterized by inflexible prices. 42

Monopolistic Markets • In monopolistic markets, there may be situations where prices do not vary immediately in the event of market changes. 43

Monopolistic Markets • In many markets, production is performed by a large organization, providing long-term research and development and using huge labor and physical capital. 44

Monopolistic Markets • Products are usually more complex than the simple butter which takes little time to consume. • They need after sale service and have been differentiated from others. 45

Monopolistic Markets • These are not simple goods produced by small-scale producers that could often respond very quickly to changes in demand. 46

Monopolistic Markets • Many markets are dominated by giant suppliers who have discretionary power over the prices they charge. • They advertise and partially orchestrate market outcomes. 47

Monopolistic Markets • They may not change the money price as market conditions vary. • They may be slow to respond to changes in the real-world conditions. • In fact, it is often expensive to change prices. • It may be cheaper to leave them unchanged. 48

Monopolistic Markets • Sellers may be unwilling to set off price wars with their rivals, so they may prefer to leave prices unchanged. • They may resort the other forms of non-price competition, like promotional offers or changing quality and product design. • Prices are sticky and markets are not neatly cleared by price movements. 49

Monopolistic Markets • People making decisions in real life do not have perfect information. • They often must proceed by trial and error. • Production takes time; plans cannot be instantaneously changed and fulfilled. 50

Monopolistic Markets • Actual price changes are the results of many factors, often pulling in different directions. • In real markets there may be constant movement and discord. • Markets may never reach equilibrium. • There may be forces at work which encourage instability. 51

Monopolistic Markets • Monopolistic firm may be quite unsure of its rivals’ actions and reactions. • The action of one firm can significantly affect the others. • Monopolistic firms may not know how their competitors will behave in new situations in the present and future. 52

Monopolistic Markets • Indeed, the firms may face a good deal of risk and uncertainty, which arise to a considerable extent from the possible actions of rivals. 53

Monopolistic Markets • Where the action of any one large firm alters the competitive environments for others, the impact of a price cut or a product change may reverberate through time, – in price wars, – promotional battles, – the instigation of new products – and the take-over and merger activity. 54

Monopolistic Markets • Firms can take two different strategies to handle interdependency. • They may try to outplay their rivals to gain an advantage on them, or they may cooperate by colluding with their competitors. 55

Monopolistic Markets • A monopolist who does not collude with rivals may conjecture that rivals will match price cuts but will not match price increases. • In that case, if one of the firms cuts its price, its rivals would react by cutting their prices; but if any one of the firms increases its price the other firms do not follow it. 56

Monopolistic Markets • The non-collusive behavior model explains why prices are sticky. • Price changes may be expensive or could simply the result of collective behavior. 57

Monopolistic Markets • Although monopolist may experience relatively stable prices for some periods and resort the other forms of non-price competition, there may be times when price cutting is used for raising or defending their own individual market share. 58

Monopolistic Markets • Monopolists often cooperate to reduce the risk and uncertainty. • However, collusion is often illegal. • Thus, they may adhere to their own informal rules and customs. • These may represent a more effective strategy for cooperation. 59

Monopolistic Markets • Despite the law and inherent problems arising from differences in costs and efficiencies between firms and difficulties relating to the share out of profit, cartels can flourish. 60

Monopolistic Markets • Cartels are the informal organizations of monopolistic firms established to cooperate in – pricing, – output – or other activities. • In cartels, firms link up to act in concert, collaborating and sometimes acting as if they were a single monopolist. 61

THE CONSEQUENCES OF COMPETITION 62

THE CONSEQUENCES OF COMPETITION • Competition is generally accepted as an efficiency-enhancing force, but it is not always a useful, beneficial force. 63

THE CONSEQUENCES OF COMPETITION • The competitive struggle to survive elicits some forms of business behavior that may promote production of goods and services more efficiently. • These can translate into broad social benefits, assuming that new efficiency is shared with workers and consumers. 64

THE CONSEQUENCES OF COMPETITION • Spurred by competition, managers will work hard to imagine ways of producing better products, and better processes. • Competition leads to more investment in both capital equipment and technology. 65

THE CONSEQUENCES OF COMPETITION • Competition also allows consumers some degree of choice in their purchases. • It thus imposes a particular form of accountability on companies to deliver high-quality and competitively priced output. 66

THE CONSEQUENCES OF COMPETITION • At the same time, however, competition imposes many economic and social costs. • Competition may also lead to irrational or destructive outcomes for the whole system. • These indicate the complex and often contradictory character of real-world competition. 67

THE CONSEQUENCES OF COMPETITION • Companies will respond to competition by cutting costs in any ways imaginable; including by reducing wages or intensifying work in socially damaging ways. 68

THE CONSEQUENCES OF COMPETITION • They may even try to shift their costs onto others: if they can find ways to impose costs of their operations on innocent parties. • Ways of doing this include pollution, the sale of unsafe products, and forcing consumers of their products to bear hidden or unexpected costs. 69

THE CONSEQUENCES OF COMPETITION • Since having a product that’s differentiated in the minds of consumers is a key source of competitive profit, companies try to create this differentiation in ways that are wasteful, useless, or even destructive. 70

THE CONSEQUENCES OF COMPETITION • Some ways of similar product differentiation are: – massive and often misleading advertising, – excess packaging, – and artificial obsolescence where products are deliberately designed to wear out or become useless prematurely. 71

THE CONSEQUENCES OF COMPETITION • Companies may not invest in innovations which they can’t patent for fear that competitors will simply copy them. 72

THE CONSEQUENCES OF COMPETITION • For similar reasons, private firms consistently underinvest in training and skills development for their workers since they worry that those trained workers may subsequently be hired away by competitors. 73

THE CONSEQUENCES OF COMPETITION • Yet, they, sometimes, spend money on attempts to frustrate or undermine their competitors’ strategies; for example, by spying, sabotaging, or needlessly duplicating their competitors’ projects. • And this spending is unproductive. 74

THE CONSEQUENCES OF COMPETITION • Competition may clearly be too intense. • It may result in all companies in an industry operating below their normal efficient scale of production, imposing a wasteful duplication of excess capacity. • It can drive profits too low, undermining the ability of firms to invest in new capital or research and development (R&D). 75

THE CONSEQUENCES OF COMPETITION • Companies which are utterly challenged just to survive will produce inferior products, simply because they cannot invest in higher quality. • If all companies in an industry suffer from the same over-competition, then the whole industry will be marked by shoddy, stagnant, even unsafe products. 76

THE CONSEQUENCES OF COMPETITION • And when companies fail, both their owners and workers suffer massive economic losses. • Competition, therefore, imposes real and substantial costs on the economy. • These costs of competition must always be evaluated against its benefits. 77