1.2.4 Business Competition

Competition Advantages & Disadvantages - Syllabus 1.2.4 (a)

• Competition = Rivalry between firms trying to sell goods/services to the same group of consumers.

• Barriers to entry = Obstacles that may discourage a firm from entering a market

• Competition levels depend on: (Use SNEAP acronym)

  • Seller’s degree of price control

    • ↑ competition → charging higher prices may lower firm demand as customers can purchase cheaper substitutes from other rivals → ↓ price control

    • ↓ competition → charging higher prices may not lower firm demand as customers have less cheaper substitutes from other rivals to choose from → ↑ price control

  • Number of buyers and sellers

    • ↑ buyers/sellers → ↑ competition; ↓ buyers/sellers → ↓ competition

  • Ease of barriers to entry

    • ↓ barriers to entry → easier to enter market (↓ capital and start-up costs required) → ↑ firms in market due to larger number of entrants → ↑ competition

    • ↑ barriers to entry → harder to enter market (↑ capital and start-up costs required) → ↓ firms in market due to less entrants → ↓ competition

  • Amount of available information

    • ↑ information about product nature, prices, production methods, costs/availability of production factors → ↑ firms can operate efficiently + attract consumers → ↑ competition

    • ↓ information about product nature, prices, production methods, costs/availability of production factors → ↓ firms can operate efficiently + attract consumers → ↓ competition

  • Product type and relationship

    • close substitutes → ↑ competition

• EPIC Q

  • Efficiency

  • Price

  • Innovation

  • Choice

  • Quality

• Competition’s effects on consumers:

  • Generally desirable, consumers get advantages from healthy competition between firms

• Competition’s effects on firms

  • Generally undesirable, firms prefer to dominate the market without threats from rivals or excess effort required for survival and success

• Competition’s effects on the economy

  • Generally desirable (more advantages than disadvantages)

• Innovative = Market exploitation of new invention (e.g. applying ideas and technologies to improve goods/services or increase production efficiency)

• Product differentiation = Firm’s attempt to distinguish its goods/services from that of its rival(s)

Large & Small Firms Advantages & Disadvantages - Syllabus 1.2.4 (b)

• SME = Small and medium sized enterprises

• Turnover = Total revenue

• Balance sheet total = Total amount of money invested in a business by owners and external investors

• Determining firm size:

• Small firms’ advantages (FLIP B)

  • Flexibility; owners /decisions makers actively involved → can quickly react and adapt to change

  • Lower wage cost; small firms’ workers usually don’t belong to trade unions → ↓ negotiating power → owner can restrict pay to legal minimum wage → ↓ wage → ↓ costs and prices

    • Small firms → ↓ employees → ↓ total wages → ↓ costs and prices

  • Innovation; competitive pressures to produce new products/methods/materials/technology to differentiate from rivals and survive + small firms have less to lose than large firms so are prepared to take risks → ↑ innovation

  • Personal service; small firms’ owners more accessible than large firms’ owners → easier to offer personal service (though usually at ↑ prices) → ↑ quality, personalized service

  • Better communication; small firms → ↓ employees → informal and/or rapid communication (owners have close contact with staff so can exchange information and make decisions more efficiently) → ↑ decision-making speed, worker motivation, and better communication

• Small firms’ disadvantages

  • Small firms → limited output → cannot exploit economies of scale → ↑ costs and average costs

  • Limited choice of financial source/institutions (moneylenders find it risky to give loans because small firms have less turnover, are considered less capable of returning loans, so face higher interest rates) → lack of finance

  • Lack of finance and resources → cannot afford wages of ↑ quality, experienced, skilled staff or the training required for specialization → difficulty attracting + cultivating ↑ quality staff

  • Lack of finance and resources available when economic conditions worsen → ↑ survival difficulty for small firms under challenging trading conditions → risk of takeovers (owners may be forced to accept unattractive takeover terms) → vulnerability to changing economic climates

• Large firms’ advantages (MEL)

  • Market domination; market domination + prestigious public reputation → price maker (can charge ↑ prices without lowering demand) → ↑ revenue → ↑ profit

  • Economies of scale; can operate in large-scale plants, bulk buy, etc → can exploit economies of scale → ↓ costs and average costs

  • Large-scaled profitable contracts; resource abundance → can win or successfully get large-scaled profitable contracts (small firms find it difficult to do so due to their lack of resources)

• Large firms’ disadvantages

  • Excess resources and time spent in administration → ↓ decision-making speed (many people must be contacted beforehand, too many managers employed, communication channels too long) → overwhelming administration systems → too bureaucratic + lowered efficiency

  • Many employees, lots of money, different store/headquarter locations → ↑ supervision needed → ↑ costs → difficulty in coordination and control

  • Effort made by 1 worker seems insignificant + people become alienated (lack of personal contact between employees due to firms’ large size) → poor worker motivation

Factors Influencing Firm Growth - Syllabus 1.2.4 (c)

• GADDE acronym

• Government regulations

  • Regulations → rules, laws, control → controls/restricts excess firm growth

  • Antitrust → prevents 1 firm from getting too large (stifles competition) → forces firms to divest (sell their assets and investments)

  • Governments monitor business activity to prevent market domination by 1 or few firms → prevents firm growth to stop them from becoming too large (e.g. investigating mergers, takeovers, and blocking those that threaten to reduce competition) → promotes healthy competition between firms → encourages innovations. , improve efficiency, and prevents consumer exploitation

  • Promotes competition

  • Funds and business services to provide advice/lower taxes to smaller firms

  • Limits monopoly power

  • Protects consumer interests

  • Controls mergers and takeovers

• Access to finance

  • ↑ access to finance (e.g. more loans from moneylenders and investors) → ↑ money to buy more resources, acquire/takeover other firms, open new stores, build new factories, develop new products, etc → ↑ growth

  • startup firms or firms in economic downturn considered less creditworthy and able to return loans → ↑ interest rates → ↓ ease of borrowing money → ↓ access to finance

• Desire to spread risk

  • product diversification (diversify product range and operation location) → risks/losses from business ventures can be distributed over a range of industries and locations → ↓ reliance on 1 good/service/industry/location → ↑ revenue sources + ↑ involvement in multiple industries/markets → ↑ growth

• Desire to take over competitors

  • ↑ takeovers/mergers of or with rivals → ↑ growth and ↓ competition

• Economies of scale

  • economies of scale → ↓ average cost (especially when more output is produced) → ↑ incentive for firm growth

  • firms that cannot have ↑ output (e.g. sole traders, barbers, uber, etc) → cannot (or difficult to) exploit economies of scale → limited business growth as average costs cannot be significantly lowered

Reasons Firms Stay Small - Syllabus 1.2.4 (d)

• SLAND acronym

• Size of market

  • markets may be too small to sustain large companies

    • e.g. luxury yacht market limited (only small group of wealthy people can afford it) → small group of consumers → businesses struggle to grow to large organizations

• Lack of finance

  • ↓ loans/capital (cannot convince moneylenders/investors that company will be successful and repay loans after growth) → ↓ money and resources to expand (cannot invest in new resources, machinery, equipment, or more labour) → ↓ growth

• Aims of entrepreneur

  • entrepreneur may prioritize family, make enough profit to satisfy needs, not be interested in growing or taking responsibility/managing other people (too large → management difficulties), prioritize other interests excluding business → owners don’t want to grow business → firms stay small

• Nature of market

  • ↓ barriers to entry (e.g. low start-up costs) → easy market entrance by new entrants → ↑ firms → ↑ competition → stops any single firm from growing too large → firms stay small

  • Market niche = Smaller market, usually within a larger market or industry

    • Large firms sometimes neglect specific needs of customers in niche markets → businesses in niche markets are generally small to tailor goods/services to this customer group

• Diseconomies of scale

  • Firm beyond maximum point of efficiency on LRAC (Long Run Average Cost) curve → diseconomies of scale → ↑ average costs

    • Diseconomies of scale → poor communication, inefficient management, ↓ employee motivation, ↑ cost, ↑ debt, ↑ interest rates, etc

  • Firms stay small to avoid diseconomies of scale (otherwise ↑ cost → ↑ price per unit output to ensure profit is made → ↓ demand → ↓ revenue and ↓ profit)

Monopoly Definition - Syllabus 1.2.4 (e)

• Monopoly = Situation where there is 1 dominant seller in the market (e.g. MTR, KGV canteen, etc)

• Pure monopoly = Rare situation where only 1 producer supplies a market (e.g. water/rail industries)

• Legal monopoly = Firm regulated by government which is protected from competitors by law.

  • Some countries consider firms occupying 25% or more of the market monopolists

• Local monopoly = Situation where 1 firm supplies an entire local market (e.g. only 1 supermarket in village → that supermarket is a local monopoly)

• Geographical monopoly = Situation where only 1 firm offers goods/services in a particular location (e.g. single petrol station on a busy road). It’s costly and inconvenient for consumers to shop elsewhere so geographical monopolies have higher market power.

Monopoly Main Features - Syllabus 1.2.4 (f)

• PUBO acronym

• Price-maker

  • Price-maker = Dominant firm can set/control prices charged in the whole market

  • Monopolists still have a downwards-sloping demand curve but can control the prices they charge

  • Can force prices higher by restricting quantity supplied in the market

  • Cannot simultaneously control price and quantity; price forced down when trying to sell more

• Unique product

  • Highly differentiated product → no close substitutes → no rivals → consumers have no choice (can only purchase goods/services from monopolist); e.g. rail travel, water provision, etc

• Barriers to entry

  • Monopolies exist due to discouraged competition, obstacles (barriers to entry) prevent new entrants from competing

  • Examples of barriers to entry (THALDBEEPP acronym)

    • Technology; large firms can access newer, complex machinery → ↑ production efficiency → ↓ average cost → ↓ price → rivals who cannot access technical economies of scale are forced out of business → ↑ barriers to entry

    • High start-up costs; ↑ cost to establish firm to compete with existing firms → ↑ difficulty for new firms with lack of financial resources or commitment → ↑ barriers to entry

    • Anti-competitive strategies (e.g. takeovers); larger firms gain control over taken-over firm’s resources → difficulty for new firm to enter market and compete on even grounds (no access to same amount of resources) → ↑ barriers to entry

    • Legal barriers; government awards contract for provision of certain goods/services to only 1 firm (legally excludes competition) → ↑ barriers to entry

    • Domination of resources; larger firms have ↑ resources → new entrants have ↓ resources so can produce ↓ output → ↑ barriers to entry

    • Branding (marketing budgets); monopolists have strong brand names → difficulty for new entrants to compete because their products will be unfamiliar and not trusted by consumers. Dominant firms spend lots of money on advertising to reinforce brand names (new entrants cannot afford this level of advertising → ↑ barriers to entry)

    • Economies of scale; monopolies are large so can exploit economies of scale → ↓ average cost → can set ↓ selling price and still earn profit → cheaper substitutes → rational consumers choose monopoly’s goods → ↓ demand for more expensive goods from new entrant firms → harder to enter market → ↑ barriers to entry

    • Exclusive deals involve selling to retailers on the term that rival products will not be stocked → ↑ difficulty for new entrants to compete

    • Patents = License granting permission to operate as a sole producer of a newly designed product (often up to 20 years) → ↑ barriers to entry

      • Allows firm to charge ↑ price (only supplier of their unique product) → can recover costs of research and development (patents encourage research and development)

    • Predatory pricing = Monopolists temporarily lower prices when they think new entrants are about to join the market → makes it harder for new entrants to compete → ↑ barriers to entry

• One business dominates market

  • 1 seller dominates (occupies most of) market.

  • Pure monopoly → only 1 supplier

  • Monopoly can exist even though there may be other firms, as long as they dominate the largest share of the market compared to rival firms

Monopoly Advantages & Disadvantages - Syllabus 1.2.4 (g)

Advantages (EIEI acronym)

• Economies of scale

  • Monopolists tend to be large → can exploit economies of scale → ↓ average cost → potentially ↓ selling price for consumers (↑ demand → ↑ revenue → ↑ profit)

• International competitiveness

  • Monopoly in domestic market → builds strength and enables effective competition with overseas rival firms → ↑ employment + ↑ national income in domestic economy

• Efficiency

  • Natural monopolies = Situation where 1 firm in an industry serves entire market at lower cost than what would be possible if the industry were composed of many smaller firms

    • E.g: inefficient for 2 or more railway operators tried to supply rail travel between the same destinations using their own railway lines (there would be large resource duplication)

  • These are markets where it’s more efficient if only 1 firm supplies all consumers

  • Sole suppliers are often unable to exploit all economies of scale in these markets

  • E.g: markets with ↑ fixed costs such as utilities and rail travel

• Innovation

  • Monopolies are large and have ↑ profits → ↑ resources and money to invest in research and development → can develop new products and new technologies that consumers will benefit from

Disadvantages (RHIL acronym)

• Restricted choice

  • Monopoly → only 1 (or very limited) supplier → no or few other producers consumers can choose from it monopolists’ goods/services are low quality → ↓ choice

• Higher prices

  • Monopolists often restrict output to force prices higher

  • Monopolists have no or few rivals → no or few cheaper substitutes for consumers → monopolists can charge ↑ prices or have ↓ quality goods/services and customer service without losing too much demand

• Inefficiency

  • Monopoly → ↓ competition → ↓ incentive to lower costs → ↑ inefficiency (care-free, sloppy approaches to business may be adopted and lead to monopolists incurring unnecessary costs)

  • Monopolists grow too large → diseconomies of scale → ↑ average cost → ↑ inefficiency

• Lack of innovation

  • Monopoly → ↓ competition → ↓ incentive to invest in research, development, and/or product innovation → ↓ innovation

  • Monopolists dominate market and can prevent/restrict entry → ↓ need to develop new products because consumers are forced to buy existing products → monopolists making ↑ profits without innovation may consider resources invested in research and development as wasted

Oligopoly Definition - Syllabus 1.2.4 (h)

• Oligopoly = Market dominated by a few large firms

• In most oligopolies, a fraction of the market is served by a number of much smaller firms. Small firms survive alongside larger rivals because they supply a market niche (i.e. a small section in a large market that’s not served by dominant firms)

Oligopoly Main Features - Syllabus 1.2.4 (i)

• Few firms

  • No exact number of firms, but usually only 3-6 dominating the market

  • E.g: Universal Music Group, Sony BMG, and Warner Music Group form an oligopoly for the music entertainment industry

• Large firms dominate

  • Few large firms dominate (occupy/obtain large proportion of market to themselves)

    • E.g: Apple, Samsung, Xiaomi, OPPO, and vivo occupy a total of 72% of the smartphone market share in 2023

  • Large firms in oligopolies are price makers, while smaller firms are price takers

• Different products

  • Products are close substitutes but differentiated (e.g. different colored/flavored toothpastes)

  • Some products have significant differences (e.g. significant difference in style, size, shape, interior, colors, etc)

  • Firms in oligopolies produce wide product ranges and deliberately try to differentiate their products from their rivals’ for higher levels of price control

• Barriers to entry

  • ↑ barriers to entry → ↓ new entrants → helps maintain oligopoly firms’ dominance

  • ↑ set-up costs + heavy investment into branding by large firms in oligopolies (new entrants’ brands are not familiar, not trusted, and they cannot afford the high levels of advertising like large firms in oligopolies can) → ↑ barriers to entry

  • NO barriers to entry → ↑ profit enjoyed by dominant firms attract new entrants → ↑ firms in market → ↑ competition → ↓ dominance of previously-dominant firms in oligopoly

• Collusion

  • Collusion = Formal agreements between firms to restrict competition

    • Markets may be shared geographically; each firm agrees to supply a particular region and not compete in others

    • Price fixing = Where all firms agree to charge the same (higher) price

    • Firms may also agree to restrict output → ↓ supply → prices forced higher

  • Collusion exploits consumers → it’s illegal in many countries

• Non-price competition

  • Firms are keen to avoid price wars → firms compete in non-price aspects using advertising and promotions (e.g. coupons, loyalty cards, competition, free offers, etc)

  • Branding (firms give product a name/term/sign/symbol) → consumers identify products easier

  • Firms advertise → creates brand loyalty so consumers continue buying their brand

  • Firms differentiate products to convince consumers their brands are different from rival firms

    • Differences may be real (e.g. MacBook VS HP laptop) or imaginary (e.g. Kellogg’s cornflakes and the supermarket’s own brand of cornflakes)

    • Imaginary differences are created or reinforced by advertising

• Price competition

  • Interdependence = Action of 1 large firm in an oligopolistic market directly affects others

  • Price war = 1 firm in industry reduces price → other firms do the same

    • Price wars tend to last short durations because they’re unsustainable for firms

    • Prices stay same for prolonged durations in oligopolies; market leader sets price and others follow because they are afraid of price wars

    • 1 firm lowers price → other firms also lower price or invest in some form of promotion (otherwise they lose sales and market shares to their rivals as consumers tend to choose cheaper substitutes) → all firms have less revenue and hence less profit

  • Short-term: price wars → cheaper prices → consumers benefit

  • Long-term: some firms squeezed out of the market because they cannot survive due to insufficient revenue and profit → less competition → the fewer, remaining dominant firms will increase prices

Oligopoly Advantages & Disadvantages - Syllabus 1.2.4 (j)

Oligopoly advantages (EPIC Q)

• Economies of scale

  • Dominant firms in oligopolies are large-scale producers → can exploit economies of scale → ↓ average costs (cost savings may be passed onto consumers as lower prices) → ↑ profit

  • Dominant firms have cost advantages as smaller rivals cannot exploit economies of scale

  • Smaller rivals only survive because they supply niche markets and do not directly compete with dominant firms

    • Niche market = Market for expensive or unusual goods/services that have small consumer groups but which can make good profits for supplying firms

• Price Wars

  • Stable market prices for long time → ↑ consumer certainty

  • Price war → ↓ price → consumers benefit in short-term from cheaper goods/services

  • Long term: price wars are short-lasting and may “squeeze” firms out the market → ↓ firms → ↓ competition → prices may be pushed even higher by surviving firms

• Innovation

  • Innovation levels may vary

  • Large/powerful firms in oligopolies dominate market → ↑ money/resources to invest in research and development → ↑ research and development → ↓ competition if 1 firm develops new good/service superior to its rivals (but this may also allow it to charge higher prices)

  • Consumers may believe the large amounts of money spent on advertising, marketing, and promotion can be spent on innovation instead

• Choice

  • Oligopolies’ competition ensures consumers are provided with choice

  • Launching new brands and innovation (non-price competition) → new products → ↑ choice

  • Small producers also provide choice by supplying niche markets

• Quality

  • Non-price competition (advertising/promotion that shapes consumers’ views), product differentiation, innovation, etc are common → ↑ quality products from some firms (but this can be subjective due to influence from marketing media as well as personal preference)

• More competition → more innovation, product development, choice, open pricing, lower costs, or even dramatic price reduction during price wars

Oligopoly disadvantages (CCP)

• Collusions

  • Collusion → firms agree to restrict competition by price fixing → no/less competition → consumers don’t benefit and pay higher prices

  • Collusion → excess investment in advertising, lack of innovation

  • All cartel/collusion members have incentives to cheat (sell more than agreed restricted output and pocket extra money they gained from selling additional output at higher agreed price to themselves. OR charge slightly lower prices for significantly increased demand to further maximize revenue and profit). Everyone is afraid of others cheating them → non-cooperative outcome

    • all members are cooperative → best collusion/cartel outcome → monopoly, profit-maximizing outcome

    • some members cooperative, some members cheat → cheater(s) get higher profit and revenue than cooperative member(s), but total outcome is worse than when all members cooperative

    • all members cheat → same or similar profit/revenue for each firm → non-cooperative outcome with less profit than both situations above

• Cartels

  • Cartel = Where a group of firms or countries join together and formally agree on pricing and/or output levels in the market

  • ↓ competition in oligopolistic market → consumers don’t benefit

  • Successful cartels act as a monopoly

  • Cartels + collusions are illegal in USA and EU

  • Oligopoly’s dominant firms collude or restrict competition by price-fixing → consumers pay ↑ prices

  • Geographic market share → only 1 firm supplies each area → ↓ choice and product differentiation for consumers

  • Cartel → ↓ competition → ↓ incentive to innovate and/or improve quality of goods/services

  • OPEC = Organization of Petroleum Exporting Countries

    • International cartel, its members include major oil-producing countries. Their aim is to restrict oil supply so prices are forced higher.

    • OPEC members regularly meet to agree on output quotas for each country, but agreement is not always guaranteed and supply restriction is not always achieved.

• Price fixing

  • All firms agree to charge the same, higher price to guarantee higher profits and revenue for all → disadvantage for consumers