Competition: A Straightforward Mode of Popping Economic Efficiency

INTRODUCTION

A market having number of buyers and sellers where no single buyer or seller is in a position to persuade the price or manage any aspect of the market and even, none of the partakers have significant control over the market. Such competitive market achieves efficiency in the allocation of scarce resources if no other market failures are present [1].

Competition, the process of rivalry between firms striving to gain sales and make profits, is central to the functioning of markets. It furthers innovation, growth and most importantly, economic efficiency all of which leads to creation of wealth and reduce wastage of resources. The term economic efficiency has no legal definition but in a usual interpretation, it is defined in numerous ways. One of such definition of it is as a term which relates to how well an economy allocates scarce resources to meets the needs and wants of consumers. In a bare plain meaning, the term stands for use of resources so as to maximize the production of goods and services.[2] The concept of economic efficiency as a whole has direct relationship with Consumer Satisfaction. Efficiency is often the common platform for all the advocates of open markets but in all, competition is an independent contributor to the promotion of efficient market. As rightly been said by Adam Smith in the following words:

“Monopoly, besides, is a great enemy to good management, which can never be universally established but in consequence of that free and universal competition which forces everybody to have recourse to it for the sake of self defense.” [3]

Here, it is pertinent to note that, Economic efficiency is achieved when productive efficiency and allocative efficiency are met.[4]

a. Productive efficiency occurs when a firm produces their product at the minimum average total cost.

b. Allocative efficiency occurs when the market is in equilibrium which means supply equals demand and therefore both consumers and producers are “contented”.

In economic context, it is the competitive market in comparison with monopoly or oligarchy which fosters the capacity of ensuring maximum while using minimum resources. The present essay entry in detail provides the instances to prove competition in market promotes economic efficiency. The following part provides the outlook of relation both concepts (Competition and Economic Efficiency) shares in the market perspective.

COMPETITION AND EFFICIENCY: INVISIBLE BUT HANDY RELATION

Competition achieves economic efficiency. In a competitive market, buyers and sellers acting independently and selfishly, channel scarce resources into economically efficient uses and than achieve the requisite market price. -Adam Smith[5]

The intensity of a competition usually results into large number of visible and invisible benefits. But each such benefit has direct and practical impact on the consumer and all related aspects of the market. Efficiency is one of such important benefits which are produced through equilibrium principle. Apart from this principle, competitive market has many key features which promotes efficiency and distinguish this market from other forms. One of the most important features of competitive market is that each firm, here, is a price taker. The whole approach of competitive market is explained in detail through following diagrammatic representation[6] and further explanation:

The competitive forces of demand and supply automatically generate the market equilibrium at price Po and quantity Qo. A competitive environment with correct price signals will inherently encourage the firms to make decisions not only with respect to static efficiency but also with respect to investment and R&D. And this gradually creates a cultural influence and encourages government policies favoring competitive markets.[7] The detailed discussion with the role of each participant in promoting efficiency is discussed as below:

Role of Demand Side (Buyer)

Competition on the demand side ensures that buyers are going to buy a good at the maximum demand price that they are willing and able to pay. This price is the total value that is fixed by society on the good produced based on the satisfaction received from the things bought.

Role of Supply Side (Seller)

Competition on the supply side ensures that sellers are going to sell the good at the minimum supply price that they are willing and able to accept. The supply price is the total cost of production, which is the value of resources and other required forces utilized by the seller.

Explanation in Illustrative Form

The example of New Zealand’s (NZ) dairy industry is important to understand the benefit of equilibrium along with the role of each participant in the competitive market. Because NZ supplies a small quantity of the overall world market, there is no way to influence the price in favor of any side. This has implications on the market, as it means the firm will have a perfectly elastic demand curve facing it. In other words, each firm having diary supply can supply as much or as little as they want to the market, but they can do it only at the market equilibrium price. This means that on the firm’s revenue curves, price is also equal to demand. This is a feature solely of a competitive market which is an indication of economic efficiency in the market.

Conclusive result

From the above explanation, we can gauged that equilibrium between the demand and supply prices means that the economy cannot generate any greater satisfaction by producing more of one good and less of another. This simply leads to the conclusion that competitive market ensures maximum and effective utilization of all resources. Here, it is important to keep in mind that Competitive markets are the cornerstone of a market-oriented economy.[8] They efficiently address the scarcity problem and answer all questions of resource allocation automatically and satisfactorily.

The handy relation of competition with efficiency is because of presence of certain important tools in the concept of competition. The following part of the entry en-lights upon existing tools of competition in detail.

COMPETITION TOOLS AND EFFICIENT MARKET

In a Competitive markets nation’s resources are used in the best effect for the production of goods and services. Illustrating the point, both theoretical and empirical research in recent years has emphasized the productive, dynamic and economic efficiency gains from the competition.[9] There are three recognized conditions exist for Economic Efficiency. These conditions are[10]:

i. All users achieve same marginal benefit; 

ii. All suppliers operate at same marginal cost;

iii. Every user’s marginal benefit = every supplier’s marginal cost.  When marginal benefit is less than marginal cost, society overall could gain by reducing provision of that item, and vice versa.

These three sufficient conditions of economic efficiency can only be achieved in a competitive market because of important tools on which Competition works while keeping the above conditional pattern of economic efficiency in mind.

The two recognized tools of competition are incentive and selection. Incentive is defined as encouragement to be productive and selection is defined as reallocation of demands between competitors. Competition improves productivity in the following ways[11]:

a. It allows the greater efficiency of resources from the division of labor and the associated gains from specialization to be reaped[12];

b. It extends the market for more efficient producers. This allows market selection to operate and cover market as much as possible with minimum but efficient production[13];

c. It introduces new low cost sources of supply and new products[14];

d. It raises management effort and squeezes out inefficiencies[15].

With the help of such tools of competition, a competitive market flourishes well and promotes utilization of resources in an efficient manner. The illustration below will explain in detail the fulfillment of all recognized conditions of economic efficiency.

Satisfaction of Conditions of Economic Efficiency in Competitive Market

Equilibrium in a competitive market results in the economically efficient level of output, where marginal benefit equals marginal cost. Explaining it further, in a market of paper mill, every mill has a right to maximizes profit and also is permitted to buy wood at the market price (up to the point where marginal benefit balances market price) from any supplier. Since all mills face the same market price, their marginal benefits will be equal. (First Condition Fulfilled). Managers of every forest maximize profit and sell wood at the market price (up to the point where marginal cost balances the market price). Since all forests face the same market price, their marginal costs will be equal. (Second Condition Fulfilled). If the marginal benefit of wood to the paper mills is less than the marginal cost of production wood, the company should cut back production.  The reduction in benefit would be less than the reduction of cost. The company’s overall profit will be higher.  The sum of buyer and seller surplus will increase. (Third Condition Fulfilled). The whole illustration is based on the equilibrium point which has already been explained in the above part. Apart from this, the following comparison with the monopolistic market will elucidate the point in a better manner. This comparison will basically en-light upon the Consumer Surplus of different markets while keeping economic efficiency in mind.

Competitive v. Monopolistic Market

Under monopoly (market of single seller), it is very usual for a seller to keep price above marginal cost and increase total revenue and profits as a result; even to cover the cost of any wastage resulted while producing a commodity and including the cost of the same in goods produced is another usual feature of monopolistic market. Now, if we assume that a monopolist and a competitive firm have the same costs, the welfare loss under monopoly is shown by a loss of consumer surplus compared to the competitive price and output. This is shown in the diagram below.[16]

This reduction of consumer surplus in monopolistic market indicates that consumer satisfaction (an important aspect of economic efficiency) can better be covered under competitive market. Here, it is important to keep in mind the role of Competition Legal Regime in the promotion of efficiency in the Competitive market. The following part will explain the same in detail. 

COMPETITION LAW AND ECONOMIC EFFICIENCY

“Robust competition laws and policies with strong institutions to enforce them are vital to improving productivity and to promoting economic efficiencies and better prices” -Observation in the Report of Commission for Africa, 2005 [17]

For yielding all fruits of competitive markets especially for the promotion of economic efficiency in the market, the role of Competition laws and policies along with strong Institutions such as Competitive Commission of India (CCI) is very important. The very purpose of enactment of Competition Law is to:

a. To take note of Cartelization of Industries;

b. To check price agreements among competing firms;

c. To maintain free competition etc.

Competition Act of number of Countries states achievement of economic efficiency as primary objective of the enactment[18]; in number of countries, introduction of most economic approach in the policy has made economic efficiency as most relevant goal of competition law.[19] Even the mandate of the advisory panel on efficiencies which was established to assess the role that efficiencies including economic one should play in the administration and enforcement of the Competition Act in the context of Canada’s evolving economy considered economic efficiency as an important reflection in the competitive market.[20] Earlier to the establishment of this panel, the European Council (EU) recommended that Canada adopt a competition law and policy that promoted economic efficiency.[21] But, here it is important to keep in mind that the term economic efficiency although is referred in number of guidelines, regulations etc. but the same has no specific definition in the legal regime. This lack of definition is a block in acute promotion of economic efficiency in the market even though statutes prefer economic efficiency as an important motto for the enactment.

CONCLUSION

In the end, we always need to keep in mind that the extensive run of perfect competition always exhibits best possible levels of economic efficiency. But to achieve optimal level, fulfillment of all of the conditions of perfect competition becomes a necessity and in case we fail to fulfill these conditions, we turn the mood of market into imperfect one with all of the potential that exists for various forms of market failure. In the end, perfect competition in the market in each case fosters economic efficiency but for imperfect competition market, fostering of economic efficiency in the long run is next to impossible without maintaining important features of perfect competition.

Moreover, as competition in market is instrumental in promotion of economic efficiency in the market and such competition is regulated under the full fledge legal regime but as stated earlier, the term economic efficiency has no specific definition; it requires a legal specific definition so that specific promotion and evaluation of economic efficiency in the market through competition can take place.

In the recent time, the term Social efficiency has been included within the concept of economic efficiency. This term means that all markets operate without any distortions, including the any generation of any sort of pollution. In practical terms, in the period when world is conscious about environment, there should not be any environmental market failures. The concept of social efficiency is evolved recently in the field of market economy but till now, its evaluation in any type of market including perfect and imperfect is unknown.

At last, I have firm believe that the thread of competitive market leads to economic efficiency because it is possible only in a contestable market to keep cost of product under control/constant check; to seek minimum wastage of scare resources and above all, to work for consumer satisfaction and happiness.

REFERENCES

BOOKS

Adam Smith, An Inquiry into the Nature and Causes of The Wealth of Nations (Pennsylvania State University, United States 2005).......1

Arthur Sullivan & Steven M. Sheffrin, Economics: Principles in Action (1^st ed., Upper Saddle River, New Jersey 2003)...... 1

Charles W. Lamb, Joseph F. Hair & Jr., Carl McDaniel, Essentials of Marketing (1^st ed., Cengage Learning, New Delhi 2008)........ 4

Nick Godfrey, Why is Competition Important for Growth and Poverty Reduction (OECD Global Forum on International Investment, London 2008)......4

Roger, J Van den Bergh & Peter D. Camesasca, European Competition Law and Economics: A Comparative Perspective (2^nd ed., Sweet & Maxwell, United Kingdom 2001).....4

ARTICLES

Damien Geradin, “Efficiency Claims in EC Competition Law and Sector-specific Regulati- on” (SSRN, November 8, 2004)................7

Wolfgang Kerber, “Should competition law promote efficiency? Some reflections of an economist on the normative foundations of competition law” (Drexl, Josef, Idot, Laurence, and Joel Moneger (eds.), Economic Theory and Competition Law 2008)........7

REPORTS

Report of Mandate of the Advisory Panel on Efficiencies.... 7

Report on Productivity and Competition: An Office of Fair Trading (OFT) Perspective on the Productive Debate, OFT 887 (January2007)......... 4

Report: Our Common Interest-2005, Commission for Africa... 6

WEB-SOURCES

http://mmoorejones.com/2011/06/20/economics-lesson-perfectly-competitive-industries/.....1

http://oldfraser.lexi.net/publications/critical_issues/1998/mergers/bm-competition.html...... 7

http://www.amosweb.com/cgi-bin/awb_nav.pl?s=wpd&c=dsp&k=competitive+market.... 1

http://www.commissionforafrica.info/2005-report............. 6

http://www.econlib.org/library/Enc/bios/Smith.html.......... 2