1.2.4 Business competition

Competition

Competition refers to the rivalry that exists between firms. 

In a competitive market, there are a large number of firms and there are low barriers to entry (it is easy to set up a business) 

In a competitive market, sellers aim to attract customers from rival firms.

Advantages of competition

  • Lower prices for consumers

  • Firms may be innovative or improve quality

  • Increases choice for consumers

  • Improves standards of living

Disadvantages of competition

  • Less profit for firms

  • May duplicate resources – too many of the same product sold

  • Firms may have to close if they don’t make enough profits

Advantages of large firms

  • They can benefit from economies of scale

  • They have large market share and therefore can dominate the market

  • They can make large profits

Disadvantages of large firms

  • Workers may have poor motivation

  • Customers may suffer from higher prices

  • The firm may suffer from diseconomies of scale. E.g. difficulties of control and co-ordination

Advantages of small firms

  • Flexibility – small firms can adapt to change quickly

  • They can offer a personal service. 

  • There may be better communication between employees

Disadvantages of small firms

  • They cannot benefit from economies of scale, so may experience higher average costs

  • They may lack finance so may be unable to grow. 

  • They may struggle to attract high quality staff

Factors influencing the growth of firms

  • Government regulation – e.g. The government can investigate and prevent mergers/takeovers. They can encourage competition by subsidising small firms.

  • Access to finance – Businesses who can’t access finance may struggle to grow. E.g. banks may be unwilling to lend to small firms. 

  • Economies of scale – Firms may be motivated to grow to achieve lower average costs. 

  • The desire the spread risk – e.g. by diversifying into new markets

  • The desire to take over competition

Reasons firms remain small

  • Size of the market – E.g. niche markets are small specialised markets. There are not enough customers in certain markets for firms to grow. 

  • Lack of finance 

  • Aims of the entrepreneur – some firms may not wish to grow. 

  • Diseconomies of scale – Firms may wish to stay small to avoid diseconomies of scale

Monopolies

A monopoly is when there is one firm who dominates the market. Some countries refer to a “working” or “legal” monopoly. This is when a firm has over 25% market share.

Features of monopolies

  • One dominant firm in the market

  • Sell a unique product

  • They are price makers – this means they can set high prices due to there being no competition. They do this by restricting output. 

  • There are high barriers to entry

Barriers to entry

These are any factors that prevent firms from entering a market

  1. Legal barriers – there may be laws in place that prevent firms from entering the market. E.g. firms may need licences to enter a market

  2. Patents – The protection of an idea or invention. Patent lasts a certain number of years. 

  3. Marketing budgets – monopolies have large marketing budgets which can result in brand loyalty. 

  4. Technology – Large firms can invest in technology which prevents others from starting up.

  5. High Start-up costs – E.g. having to buy machinery/technology/factory. 

Advantages of monopolies

  • Profits – monopolies make large profits. They can invest these into R&D and become more innovative

  • Profits – higher tax revenue for government

  • Economies of scale – firms can benefit from internal economies of scale

Disadvantages of monopolies

  • They can charge higher prices 

  • Restricted choice

  • Lack of innovation – no incentive to invest profits due to lack of competition

  • Inefficient – lack of competition means there is no incentive to keep costs down

Oligopolies

An oligopoly is a market structure where there are few large firms who dominate the market. E.g. mobile phones, supermarkets

Features of oligopolies

  • Few large dominant firms 

  • Substantial barriers to entry 

  • Firms act interdependently (action of one firm affects behaviour of another)

  • Firms produce a branded product – products likely to be similar but slightly differentiated.

  • Collusion

  • Non-price competition

  • Price competition

Interdependence

After Apple decided to develop splash proof phones, Samsung also developed a similar product. If one firm in a market decides to lower the price, others may copy. If one firm increases the prices, other firms will keep their prices unchanged. 

Behaviour of oligopolies – non collusive

  • Oligopolies can choose to compete OR collude. 

  • If they compete, they may use pricing strategies e.g. lowering their price to entice consumers. Often this may result in a price war – this is when one firm lowers the price, then another lowers it further, then the original firm lowers their prices further etc). 

  • Firms could also compete using non-price competition. This is any other way to entice customers not using price e.g. branding

Collusion

  • Collusion is when firms (or countries) work together (cooperate) to benefit all firms.

  • Collusion can be formal or informal. Formal collusion is when there is an agreement in place. This is generally illegal

  • Collusion reduces competition as firms act as a monopoly. 

  • Formal collusive agreements include:

    • Fix prices (increase prices)

    • Restrict output – reduce availability of products so consumers “panic buy”

    • Marketing strategies (or lack of) 

    • Product agreements 

Advantages of oligopolies

  • Choice – There may be some choice. Especially if oligopolies are engaging in non-price competition. 

  • Quality and innovation –Same as above

  • Economies of scale – Large firms may be able to benefit from lower LRAC. 

  • Price wars – Firms may decrease prices to gain customers 

Disadvantages of oligopolies

  • Collusion  - firms cooperate to reduce competition

  • Lower quality/innovation/choice - If there are a few firms in the market, there may be lower quality etc. 

  • Shut down – if competitors engage in price and non-price competition, other firms have to shut down

Cartels

  • A cartel is a form of collusion.

  • Two or more firms form an agreement and act like a monopoly.  

  • They normally fix prices and restrict supply

  • They are usually illegal.