Why producers compete
In a market economy firms compete because they are chasing the same customers, and a customer who buys from one firm has not bought from another. The specification asks for the reasons why producers compete, and the honest answer is that all of them come back to profit:
• To win a larger share of the market, and so sell more • To increase revenue and profit • To survive, since a firm that loses customers to rivals eventually closes • To build a reputation and customer loyalty that protects it in future
Firms compete in two broad ways, and questions often ask for both. Price competition means cutting prices, running offers and sales, or price-matching rivals. Non-price competition means competing on everything else — quality, branding and advertising, customer service, delivery speed, loyalty schemes, opening hours, and product features.
How competition affects price is the mechanism to be able to explain. If several firms sell a similar product, a customer who finds one firm charging more simply buys from another. Any firm that sets its price above its rivals loses sales. So each firm is under constant pressure to keep its price down, and the market price is pushed towards the lowest level at which firms can still cover their costs.
The reverse is what happens where competition is absent. A firm with no rivals loses far fewer customers by raising its price, because the buyers have nowhere else to go — which is the whole reason monopoly matters.
The impact of competition
Monopoly and oligopoly
A monopoly is a single firm dominating a market. Because buyers have no alternative, it can raise price without losing many sales, and it faces less pressure to improve quality or innovate. That is the case against monopoly, and it is why governments regulate them.
The case for is worth knowing too, since evaluation questions expect both sides. A very large firm can achieve economies of scale, so its average costs are lower — and some of that saving may reach consumers. High profits can fund research and development that a small firm could not afford. And some industries are natural monopolies: it would be wasteful to build four competing sets of water pipes to every house, so a single supplier is more efficient, and the answer is regulation rather than competition.
An oligopoly sits between the two: a few large firms with most of the market. They watch each other closely, which produces the behaviour the exam looks for — firms are reluctant to cut prices because rivals would match the cut and everyone would end up earning less, so they compete on advertising, branding and loyalty schemes instead.
Worked example
Two of the four large supermarket chains in a country merge. Evaluate the likely effect on consumers.
- Identify the change in market structure: four firms becoming three concentrates the market further.
- Fewer competitors means less pressure to keep prices low, so prices may rise.
- Choice narrows, and the merged firm has more power over its suppliers and its customers.
- Now the other side, which the mark scheme will want.
- A larger firm can gain economies of scale, cutting average costs, and may pass part of that on in lower prices.
- Reach a judgement and state what it depends on.
Answer: Consumers are likely to lose overall. With three firms rather than four there is less pressure to compete on price and less choice, and the merged firm has more power to raise prices without losing customers. Against that, the merged firm gains economies of scale and may pass some of the saving on. Which effect dominates depends on how strong the remaining competition is and whether a regulator intervenes — with only three firms left, the risk of higher prices is the greater one.
Common mistake
A monopoly is not simply a big firm. It is a firm that dominates its market, so buyers have no realistic alternative. A large firm in a market full of equally large rivals is not a monopoly.
- Monopoly
- a single firm dominating a market; because buyers have no alternative, it can raise price without losing many sales and faces less pressure to improve quality
- Oligopoly
- a market dominated by a few large firms
Before you practise
- Firms compete for market share, revenue, profit, survival and reputation.
- Price competition is cutting prices; non-price competition is quality, branding, service and innovation.
- Competition pushes price down because a firm charging more loses customers to rivals.
- Consumers usually gain lower prices, more choice and better quality.
- Producers face lower margins and higher costs of competing, but become more efficient.
- A monopoly is one dominant firm: higher prices, less choice, less incentive to innovate.
- Monopolies can achieve economies of scale, and a natural monopoly avoids wasteful duplication.
- An oligopoly is a few large firms that avoid price wars and compete on branding instead.