Competition Economics: Imperfect and Perfect Competition

In economics, competition refers to the process by which various sellers each try to offer better products, lower prices, and other advantages to choosing their wares over a rival’s.

Economic competition allows the so-called “invisible hand” of the market to reward the most effective seller, rather than relying on a central committee or monopoly to plan the economy. In less technical jargon, this means whoever provides the best product at the lowest price is likely to reap the highest rewards, at least theoretically.

In macroeconomics, competition refers to the process by which countries compete with each other for resources. In microeconomics, it refers to the process by which individual companies jockey with each other to appeal to consumers.

Government policy makers have a vested interest in creating open markets free of anticompetitive practices. This means cracking down on price-fixing, passing antitrust laws to break up monopolies, and occasionally providing subsidies to foster a more competitive environment. For example, in the US economy, the Federal Trade Commission helps to regulate industry by making it more competitive. Still, not every country has competition policies in place—some might try to reduce the amount of competition and shore up resources for the state itself or favored companies.

Most traditional economists believe increased competition leads to greater benefits for all economic participants. Here are three core benefits to consider:

1. 1. Greater innovation: Economic analysis indicates more competitive markets lead to both increased innovation and greater overall economic growth as a result. If entrepreneurs feel the need to compete with other companies, they have an incentive to provide more unique and far less homogenous products for their customers. Competition also leads many brands to develop new products regularly to stay relevant to consumers.
2. 2. Lower prices: When a large number of companies compete with each other, one of the easiest ways for one to gain a competitive advantage over the others is to offer lower prices. As such, greater market competition leads to greater price competition, resulting in retailers passing on lower costs to their consumers.
3. 3. More consumer choice: Product differentiation due to competition among sellers often gives consumers greater decision-making power. In a competitive economic environment, customers can choose between different products from a wide variety of brands rather than buying the same identical products one week to the next from a small number of companies or even a single firm.

Economic competition is a simple concept with many complex applications. Here are seven terms to keep in mind when trying to understand what competition means in the real world:

1. 1. Competitive advantage: As companies compete to attract the largest number of buyers, they seek advantages over each other. For example, the company might gain access to a raw material at a lower price than another company. This allows them to lower the total cost of their own products, granting them the ability to appeal to more customers and gain a competitive advantage over other similar companies.
2. 2. Demand curve: Competition helps flatten out the elasticity of the aggregate demand curve for a given good. The economic theory of supply and demand, in part, states the more demand there is for a product, the lower the market price will be. When many firms compete to provide similar products, they boost the supply curve, which in turn lowers the demand curve and prices as a result.
3. 3. Imperfect competition: In the real world, the only type of market possible is one of imperfect competition. This means externalities—like firms acquiring other companies through mergers, securing higher amounts of imports and exports, and so on, reducing competition as a result—make it hard for markets to retain their ideal competitive power.
4. 4. Market share: In the international economic arena, companies do their best to compete their way into gaining the greatest possible portion of the overall market structure. The greater market share you have, the more market power you gain—and this gives companies a decisive competitive advantage over smaller firms in both the long and short run.
5. 5. Monopoly: In short, monopolistic competition is no competition at all. A monopoly occurs when a single firm takes over the entirety of a market when it comes to a given product. This gives them the ability to offer their goods at higher prices than they possibly could in a more competitive arrangement. As such, governments throughout the world often step in to prevent monopolies from forming so people can offer substitute products and increase competition for the benefit of consumers.
6. 6. Oligopoly: Similar to a monopoly, oligopolies operate as cartels of sorts to create barriers to entry to new firms and startups. In the economic scenario of an oligopoly, a small group of companies offering similar products takes over a portion of the market to crowd out all other competition.
7. 7. Perfect competition: Both classical and neoclassical economists described a utopian economic system of competition toward which societies could aim. In such a system, marginal costs would always equal marginal revenue. In other words, no company would ever make profits, and consumers would always have perfect information to make the best choices possible when it comes to purchases. Needless to say, perfect competition has never existed in the real world.

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