Competition

On sacred competition

Competition is one of the most important institutions - if not the most important - of capitalism. In fact, for many economists, competition is precisely the engine that accelerates technological development and innovation. This is because in the entrepreneurial quest to maximize profit, the capitalist tries to provide higher quality goods at a lower price, which also benefits consumers.

(Perfect) competition in the traditional model

The Cambridge dictionary defines “competition” as “a situation in which someone is trying to win something or be more successful than someone else”. In economics, there can be different types of competition, but in general we refer to it as the competition generated between different suppliers in the same market to sell a certain good.

The main characteristics of what we understand by “competition” have mutated over the centuries, and although they have some similarities, we cannot guarantee that what David Ricardo, Smith or Marx understood about it is the same as what the traditional model of supply and demand that accompanies us to the present day imagined closer in time.

In the mainstream model, the criterion most commonly used to classify the different types of market is the one that defines what type of market is being

market is that which defines the type of competition within it. In its most widespread version, it is assumed that this competition has 4 main features:

1. There is a high number of suppliers and demanders, so that none has market power, understood as the ability to fix price.

2. There is homogeneity of the product being marketed (there are no differences by brand or quality).

3. There is market transparency (suppliers and demanders have the same information).

4. Freedom of entry and exit of companies, i.e. there are no barriers to the entry of new competitors.

When all these assumptions are met, a condition favoring consumers is generated: the price at which the product will be sold will not exceed the (marginal) cost of producing it. To understand this, imagine a product whose unit cost (including a profit for the capitalist) is USD 10 and a company offers it at USD 15 on the market. If the 4 assumptions mentioned above are fulfilled, then a new firm could offer it at USD 13 and thus guarantee that all consumers would prefer to buy from it. However, another company would appear to be able to offer it at USD 12 and so on until it establishes a price that equals the cost.

In such cases, the market is said to act efficiently.

What happens when there is no competition?

The problem we have is that in most real cases, it is difficult to find markets that meet the four assumptions mentioned above. When any of these characteristics is not in place, we speak of “imperfect competition” and it usually includes some kind of “market power”.

Imagine, for example, a market in which there is only one supplier with a patent that guarantees it is the only supplier of the good in question: it could set a price much higher than its cost, and consumers who want to buy the good would have no alternative!

In general, for market power to exist, there must be some kind of barrier that restricts the entry of new competitors. The most frequent barriers are:

Economies of Scale: When fixed costs are high, potential firms can only enter the market with a significant (sometimes unattainable) level of production, in order to compete with the average costs faced by established firms.

A particular case of this type of barrier occurs with the so-called “natural monopolies”: those industries where it is more efficient and safer for society as a whole to have a single service provider. Can you imagine a city with 10 gas or electricity companies? Each would have to have its own pipelines, crossed, which would make each new installation more costly and inconvenient. That is why drinking water, sewage systems, domestic energy supply, or railroads are often taken as examples of “natural monopolies”.

Legal barriers: Contractual or bureaucratic restrictions that impede the production of a certain good or service, such as the

production of a certain good or service, such as specific licenses or authorizations, intellectual property or patents.

Product differentiation: In some cases, even when a good or service is made to cover the same “need”, we cannot speak of homogeneous products. For example, when there is a cumulative customer preference for the company's brands and reputation.

pALLicies in competition:

Given the importance of competition as a driver of growth and innovation, governments are often concerned to ensure that there are no limitations to competition, and to encourage it in the most transparent way possible. To learn more about the role of the State in the preservation of competition, you can look at “antitrust laws”.