Competition

Competition is a means by which limited resources can be allocated among rival bidders. The degree to which it is present in a market has a strong influence upon pricing in that market. Unrestricted or perfect competition is a hypothetical condition in which no-one is able to influence the market price of a product. At the other extreme, absolute monopoly, or the total absence of competition in the supply of a product, would give its holder the sole ability to influence the market price of that product. Perfect competition and total monopoly are conditions which can readily be analysed to give definite and straightforward answers, and for that reason they provide a valuable starting-point to the study of the microeconomics of market behaviour. Competition theory, is concerned with economic behaviour in markets whose characteristics lie between those hypothetical extremes. Its practical importance lies in the fact that competition or its absence can have a major influence upon the welfare of a community.

Perfect Competition

Definition

The hypothetical world with which the concept of perfect competition is concerned is one in which the market for each category of product has the following characteristics:

(a) All market shares are small. No supplier enjoys a share of the market which is large enough to enable him to influence the price of that category of product.

(b) No collusion. Each supplier acts independently.

(c) No barriers to entry. There is nothing to prevent any new supplier from entering the market for any category of product.

(d) Homogeneity of product. All suppliers of each category of product are known to all buyers to supply identical products.

Suppliers are assumed to maximise their products and buyers are assumed to seek value for money. After a settling-down period, a market price emerges for each category of product. A supplier who attempts to sell a product above that price will find no buyers and a buyer who attempts to buy a product at below that price will find no sellers.

Those characteristics define the conditions for perfect competition among suppliers of products. They may similarly be defined in relation to suppliers of labour. And for pure competition to apply to the market as a whole, conditions analogous to (a) and (b) must also be satisfied by buyers: there must be no dominant buyers, and buyers must not collude.

Efficiency implications

Economics textbooks analyse the consequences of perfect competition for buyers and for sellers. The term optimal resource allocation is used to describe the theoretical outcome for the community as a whole. In non-technical language, this can be taken to mean the efficient allocation of resources as between different categories of product. Perfect competition ensures that the community's resources are used efficiently in the sense of making people feel well-off. If resources are allocated optimally, then people would not, for example, feel better off if they were able to afford more meat and less fish, nor vice versa. It cannot, however, be concluded that perfect competition maximises economic efficiency. Competition theory,as outlined above, says nothing about productive efficiency, which is a component of economic efficiency. Nor is it strictly correct to say that perfect competition maximises economic welfare. The concept of economic welfare encompasses the way in which wealth is distributed as between different members of the community, and it cannot be claimed that perfect competition necessarily leads to an ideal distribution of wealth. The propositions which emerge from the concept of perfect competition are to do with the way in which resources are allocated between products, and not with how the product is manufactured, or to whom it is distributed.

Externalities

The outcome will not necessarily be efficient if any supplier can impose costs on others. In economics terminology these are termed externalities. The conventional example is a supplier who pollutes the environment. The allocation of resources need not then be efficient because of the possibility that some people would feel better off with fewer goods in exchange for a cleaner atmosphere. Other examples include traffic congestion and mining subsidence. The theoretically ideal solution is for the polluter to compensate those affected.