Competition

Why producers compete

Competition is where more than one firm is trying to sell similar products to the same consumers. In a competitive market there are a lot of buyers and a lot of sellers so that no individual can control the market.

The key reason businesses compete is to attract customers and make a profit, but it is not always as simple as that. In reality the reasons and manner in which firms compete changes as businesses evolve.

Stage of business Effects on competition
Market entry When entering a new market a firm and their products will be unknown. In order to establish themselves they may spend a lot on marketing. They may also offer low introductory prices or even product give-aways in order to attract customers. If the new player in the market is large, this may force existing firms to respond with their own discounts and offers.
Growth Once a firm has entered a market they will be looking to survive and then grow. Just to survive and grow a business needs to find a way to both retain existing customers and attract new ones. This may lead to them expanding their product range to meet the needs of more people.
Maturity A firm with a developed reputation and solid customer base cannot just sit back and expect that to continue indefinitely. They need to be constantly innovating and developing new and exciting products as well as adapting current products to better meet the needs of customers.

How firms compete

Type of competition Description
Price competition Probably the most obvious way in which firms compete is on price. Larger producers tend to have lower average costs and so are more able to compete on price. Firms that's prices are too high will not be able to compete, but in setting their prices they must also consider their costs. A firm cannot consistently sell below cost or they will go broke.
Non-price competition There are a number of factors consumers consider besides price that give firms other ways to compete. You should easily be able to think of several brands that are more known for their quality or the innovative products they produce. Firms use advertising to try and promote brand loyalty and create awareness of what they see as the product's features. Some firms focus on providing high quality customer service.

How competition affects price

Effect of increased competition

An increase in competition means there are more firms in the market or one or more of the firms in the market has grown in size. This means a right shift of supply. As you can see from the diagram on the left, this leads to a lower equilibrium price and higher equilibrium quantity.

The elasticity of demand in the industry will make a big difference to the effect competition is likely to have on equilibrium price and quantity. If you look at the image on the right you can see that when demand is elastic and competition increases there is a small drop in equilibrium price but a large increase in quantity supplied. However if demand is inelastic then it will lead to a large drop in equilibrium price and only a small increase in equilibrium quantity.

It is also possible for competition to actually lead to an increase in costs and a left shift of supply. This might happen if firms needed to spend a lot of money on marketing or research and development in order to compete.

If there were to be a firm go out of business, or two competitors merge causing competition to decline then we would also see a left shift of supply.

Competition and elasticity of demand

The economic impact of competition

The effect on consumers

In general competition provides a lot of benefits to consumers as it can lead to lower prices, innovation and therefore better quality and a wider variety of products. All these things are positive for the consumer giving them more and or better quality stuff and improving their standard of living.

There can however be negatives for consumers from competition. In an effort to compete producers may use preservatives or chemicals that enhance production or shelf life but have harmful side effects. Some advertising and methods of promotion may lead consumers to purchase more than they would or things they do not need.

The effect on producers

You might initially think that competition is bad for business as it stands to fore them out of business. While it is true that inefficient firms may be forced out of business by competition, it is generally considered that competition has positive effects for producers.

Competition forces firms to become more efficient. This leads them to seek out technical innovation. The current computer age has already led to many changes but still stands to revolutionise many processes to the same extent as the industrial revolution. Automation can greatly increase productivity and if widespread GDP, however it may come at the cost of jobs.

Monopolies, oligopolies and competitive markets

Type of market Definition Features
Competitive market A market with lots of buyers and sellers The price is set by market forces with forms responding to consumer demand and the actions of their competitors. This is thought to be a very efficient type of market and is expected to lead to lower prices and higher quantities sold.
Oligopoly This is an industry with only a few small firms that have the majority of the market share. The rule of thumb is if 5 companies have over 50% or the market then it is an oligopoly. It is likely these industries are controlled by a few large firms but small and medium firms may also exist in the industry. Larger players have a greater ability to influence prices but it is dependent on how their competitors behave. For them to get together and agree not to compete on price is a crime known as collusion. However it can be seen that in some industries firms choose not to compete with each other on price. Oligopolies are considered less efficient than competitive markets. How efficient they are largely depends on how active the competition is.
Monopoly A true monopoly is where there is just one producer in an industry. However, a firm can be said to hold monopoly power if they have at least 25% of the market. In a true monopoly they are free to set the price but consumers will determine the quantity sold. Monopolies are generally not considered to be efficient because they have no incentive to be and prices are expected to be higher in these industries. However, it is possible that due to their large size monopolies may gain economies of scale. This can allow them to make efficiency gains. Firms with monopoly power have some control over prices but will still have to respond to their competitors.

Knowledge check


Questions:
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Question text


Exam style questions

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Questions

Explain what is meant by non price competition and give an example. (2 marks)


Non-price competition is where firms compete for customers in ways other than by having the lowest price.(1) e.g. service, quality of product etc.(1) Allow any suitable example.

Explain one way a business at market entry stage may compete. (2 marks)


Needs to be a way and an explanation for two marks:

They might spend a large amount on advertising(1) because they are completely unknown and need to create awareness of their product.(1)

They might offer low prices or even product giveaways(1) in order to attract new customers.(1)

Explain what an oligopoly is and give an example of one. (2 marks)


An oligopoly is a market where a small number of firms control the majority of the market share.(1) e.g. UK Supermarkets or UK Banks(1) Allow other suitable examples.

Draw a supply and demand graph showing the effect of increased competition. (2 marks)


Effect of increased competition

You don't have to draw the dotted lines but you need to make sure you labelled the x and y axis and the supply curve itself.

1 mark for showing a right shift of supply, 1 mark for all the labels.

Explain what monopoly power is. (2 marks)


When one firm controls 25% or more of their market(1) they acquire some of the influence normally attributed to a monopoly.(1)



Case study/Scenario

Trevor's Taxis is a taxi firm based in the village of Stonding. You can get other taxis from the nearby town of Swanbridge but only to and from Swanbridge. For trips between Stonding and its neighbouring villages Gunderidge, Hobden End and Fallstead Trevor's Taxis have a monopoly. These routes are often busy on a Friday and Saturday evening when people often travel between the towns to meet up with friends.

Trevor is thinking about investing in another two taxis but is concerned about the possibility of another firm setting up in the area.

Analyse the effects on Trevor's Taxis of a new taxi firm operating in the same area. (6 marks)


Sample answer:

Trevor may lose passengers to the new firm{AO1} leading to less demand for his taxis.{AO2} This could lead to lower revenue{AO3a} which may have to make him reconsider his expansion plans.{AO3a}

Trevor may have to decrease his fares in order to attract passengers{AO2} This will mean less revenue if demand is inelastic.{AO3a}

Additional notes:

There are a number of other factors you might have analysed here including

He may have to increase advertising, or have to improve service or compete for drivers with the new firm, all of which would lead to increased costs and so lower profits.


Evaluate the extent to which the locals in the area benefit from Trevor's Taxis being a monopoly. (6 marks)


Sample answer:

Trevor's Taxis will be guaranteed a lot of customers and make a good profit.{AO2} It mentions that Trevor is thinking of investing in more taxis which would mean shorter waits for passengers wanting a taxi{AO3a} and a better quality of service.{AO3a} However Trevor may realise that his PED is more inelastic because customers have no choices and he may charge higher prices{AO3b}. This means customers would have less money to spend on other wants.{AO3b}

If Trevor uses his profits to invest in more taxis and people get a better service they may not mind paying a little bit more. However the extent to which he raises prices if he does would have an effect on whether his customers benefit or not.{A03b}

Additional notes:
Make sure you are in context. Here I have talked about passengers and fares and mentioned his desire to invest in new taxis mentioned in the scenario.

It's an evaluate question so you are looking to cover both sides of the argument.

The concluding statement should say in what crcumstances it will benefit customers and when it won't not whether you think it will or won't.


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