Economics Essays - Definition of Competition

Definition of Competition

The natural price or the price of free competition within a particular market sector is the lowest which can be taken by the consumer. It is also the lowest which the sellers can commonly afford to take, and at the same time continue to do business. As Adam Smith (1776) puts it,

”In every profession, the exertion of the greater part of those who exercise it, is always in proportion to the necessity they are under of making that exertion, and where, competition is free, the rival ship of competitors, who are all endeavouring to jostle one another out of employment, obliges every man to endeavour to execute his work with a certain degree of exactness”.

Competitive markets provide the best means of ensuring that the economy’s are put to their best use by encouraging enterprise and efficiency, and widening choice.

Where markets work well, they provide strong incentives for good performance, encouraging firms to improve productivity, to reduce prices and to innovate; whilst rewarding consumers with lower prices, higher quality, and wider choice.

As Amelia Fletcher, Director of Markets and Policies Initiatives summed up, ‘Competition is a rivalrous process, in which firms compete effectively to give consumers a better deal’. Competition is not the same as competitiveness. She also adds that it is the competition process that drives competitiveness, ensuring that a business continues to move forward.

The competitiveness of the market depends on individual firms’ power to influence market prices. The less power an individual firm has to influence the market in which it sells its product, the more competitive that market is.

Market power arises when one or a small number of firms dominate a market and it is difficult for other firms to enter. Governments around the world at all levels have an important role to play when this happens. The key to a successful framework for government policy is to focus on market failure to ensure that interventions are targeted on the problem.

Therefore, the overall aim of the government’s competition policy is to encourage and enhance the competitive process to bring the wider benefits to the UK economy.

With this in mind, we can now move on to talk about the current UK government framework on competition policies, market failure (why government intervention would be necessary), and an analysis, i.e. evidence to support my arguments.

A) The current UK government framework on Competition Policies stated in 1998

The ultimate responsibility for competition policy in the United Kingdom lies with the Secretary of State for Trade and Industry, but application of the policy is in the hands of two main institutions, the Office of Fair Trading (OFT), and the Competition Commission (CC) which came into being on the 1^st of April 1999.

The government has built a sound framework for competition authorities to address anti-competitive behaviour across the economy:

The Competition Act 1998 gives the Office of Fair Trading (OFT) much stronger powers to address anti-competitive behaviour. It prohibits anti-competitive agreements, and abuses of dominant market position. Firms which breach the law face penalties of up to 10% of their turnover in the market in question for up to three years of an infringement;

The government also announced its intention to reform the merger regime, so that decisions on individual cases are taken by independent competition authorities using a competition – based test;

The Financial Services and Market Acts 2000, gives the OFT and Competition Commission new powers to scrutinize the competition effects of financial services regulations;

The Government also increased the OFT’s budget from 20 million in 1997 to 32 million in this financial year. The Government also appointed a new Director General, John Vickers, a leading economist with strong expertise in competition matters, although his tenure will be short lived, when the OFT is dissolved on the 1^st of April 2005, and then replaced as a Corporate body, with a Chairman, and four other members all appointed by the Secretary of State for Trade and Industry;

The government also announced that it intends to legislate to provide the OFT with a new board structure. This will help to broaden the basis for deciding the OFT’s strategy;

The government also stated that it would confer a new role for the OFT (and the sectoral regulators) to assess when laws and regulations create barriers to entry and competition; and

The Government also commissioned a peer review of the UK’s competition regime. The peer review is to provide a benchmark against which to measure progress against the DTI’s Public Service Agreement target of having ‘the most effective competition regime in the OECD’.

The goal of the OFT is to make markets work well for consumers. It has powers of enforcement of competition and consumer protection rules; it can initiate investigations into how any specific market is working; and it is involved in communication to explain and improve awareness of competition rules and policy.

The OFT may refer mergers that it deems to be anti-competitive to the CC and it may also refer markets where competition is perceived to be not working well. Additionally, the newly established Appeal Tribunals hear appeals against decisions of the Director General of Fair Trading and the Regulators of Utilities in respect of infringements of the prohibitions contained in the (1998) Act concerning anti-competitive behaviour and abuse of a dominant position.

A leniency programme was also setup to make it easier for cartels (monopolies and oligopolies) to be exposed. Firms that cooperated fully with the OFT’s or Competition Commission under the leniency programme could have up to 50% of penalties imposed by the OFT removed and in some cases a 100% removal of penalty. It all depends on how mush the firm or cartel cooperates with the OFT.

B) Market Failures (why the markets cannot be relied upon)

The term market failure describes the failure of the market economy to achieve an efficient allocation of resources.

When firms face negatively sloped demand curves, price will exceed marginal cost in equilibrium. Thus, no real market economy has ever achieved perfect allocative efficiency.

The conditions for efficiency are meant only as a benchmark to help in identifying sources of allocative inefficiency, called market failures.

These sources provide scope for possible government intervention designed to improve market efficiency, even if not to achieve complete efficiency.

There are several important circumstances under which markets fail to allocate resources with reasonable efficiency, let alone achieve the optimal allocation of resources:

1) Where producers with excess capacity set positive prices;

2) Where there are resources that can be used by everyone but belong to no one, this is called ‘common property resources’;

3) Where there are goods whose consumption cannot be restricted to those who are willing to pay for them, these are called ‘public goods’;

4) Where people not party to some market bargain are none the less significantly affected by it, these are called ‘market externalities’;

5) Where one party to a market transaction has fuller knowledge of its consequences than is available to the other party, this is a situation referred to ‘asymmetric information’;

6) Where needed markets do not exist;

7) Where substantial ‘monopoly power’ causes prices to diverge from marginal costs.

Coping with these market failures provides governments with major functions in addition to law and order.

Rivalrous and excludable goods

Economies must allocate resources between the production and consumption of four major classes of goods and services. They are excludable and non-excludable goods; and rivalrous and non-rivalrous (up to capacity) goods.

A good is rivalrous if no two people can consume the same unit. For example, if you buy and eat an apple, no one else can buy and eat that same apple.

A good is excludable if people can be prevented from obtaining it. Excludability requires that an owner be able to exercise effective property rights over the good or service in order to determine who uses it, typically, only those who pay for the privilege.

Most goods that we buy are rivalrous and excludable

Goods and services are non-rivalrous when the amount that one person consumes does not affect the amount that other people can consume.

They are also non-excludable when, once produced, there is no way to stop anyone from consuming them.

Externalities

A perfectly competitive economy allocates resources optimally because price equals marginal cost in all lines of production.

For this outcome to happen, it is necessary that all costs are incurred by the producers and all benefits are reaped by their customers.

This localization of costs does not occur when there are externalities, which are costs or benefits of a transaction that are incurred or received by other members of the society but not taken into account by the parties to the transaction.

They are also called third-party effects and sometimes neighbourhood effects, because parties other than the primary participants in the transaction (the consumers and the producers) are affected.

Externalities arise in many different ways, and they may be beneficial or harmful. They create a divergence between the private benefits and costs of economic activity and the social benefits and costs.

Cartels

Cartels and price fixing agreements among oligopolists, whether explicit or tacit, have long met with public suspicion and official hostility.

These, and other non-competitive practices, are collectively referred to as ‘monopoly practices’.

Other aspects of monopoly behaviour are non-competitive behaviour of firms that are operating in other market structures such as oligopoly.

The laws (Competition Act and Enterprise Act) and other instruments that are used to encourage competition and discourage monopoly practices make up competition policy and are used to influence both the market structure and the behaviour of individual firms.

The goal of controlling market power provides rationales both for competition policy and for economic regulation.

Competition can be encouraged and monopoly practices discouraged by influencing either the market structure or the market behaviour of individual firms.

By and large, UK competition policy has sought to create more competitive market structures where possible.

Where such structures could no be established, policy has sought to discourage monopolistic practices and to encourage competitive behaviour (leniency programme).

C) Analysis (Evidence supporting my argument)

In March 2000, the OFT imposed penalties on two national bus companies, which run subsidiaries based in Leeds and Wakefield, for illegal cartel activity. Senior staff from the two bus companies concerned, Arriva and First Group, had two meetings in a Wakefield hotel, in which an agreement was met for Arriva to withdraw its five buses from two of its route in Leeds, leaving First Group with no competition on these routes. In turn First Group withdrew its buses from two other routes that Arriva would take on.

This was the first time that the OFT would impose penalties for cartel activity under the Competition Act of 1998.

Four case studies (Davies, Coles, Pike, and Wilson; 2004) in which there were market imperfections that lead to government intervention in the UK are looked at also. They are:

Retail Opticians (1984): This is an example of market deregulation, in which there was the removal of professional restrictions on advertising and entry into a retail market. It was hoped that this would lead to more competitive pricing, and perhaps wider choice, but there were fears that professional standards might be jeopardized and that advertising might be misleading.

International Telephone Calls (1996): Deregulation of the market for international telephone calls came towards the end of a decade of liberalization of the telecoms industry. The process had started with the privatization of BT, and continued through the 1990s with the gradual controlled emergence of new entrants. It was also against a backcloth of rapid technological change.

Net Book Agreement (1995): The Net Book Agreement was a long standing example of resale price maintenance on the retail sale of books. Following intervention by the OFT, this agreement was ended in the mid-1990s, with hopes that this would free up price competition by retailers and publishers. However, there were fears that fiercer competition might lead to the demise of the smaller book shop, reduced stockholdings, and ultimately fewer books being published.

Replica Football Kits (2002): This is a very recent antitrust intervention by the OFT, which found evidence of price fixing of replica football kits by manufacturers and retailers. Financial penalties were imposed under the new UK competition legislation, and it was hoped that the outlawing of this collusion would lead to large reductions in price.

SUMMARY AND CONCLUSION

This report has looked at the different concepts of Competition. We have also highlighted the current regulatory framework governing competition policy across all sectors within the UK economy. Additionally, we have stressed the important of not leaving sector markets to free market forces because left alone, the markets cannot be relied on due to factors mentioned in the latter pages of this paper. And finally, we have elaborated on proven empirical analysis to show reasons why government intervention is sometimes necessary to correct sector markets so as to prevent market failure.

We can conclude here that although government policy may often be important and necessary for change, it is sometimes rarely sufficient. One would need a pool of resourceful entrepreneurs, capable of exploiting changed market conditions. Government interventions are done in order to promote competition within a market sector, so as to provide a lower price and better quality product for consumers. However, this raises the possibility of harmful side effects, because market imperfections are sometimes put in place to help protect some other desirable objective. I.e. protection of professional service standards amongst opticians.

Nevertheless, the evidence provided above shows little sign of harmful side effects with regard to firms in any of the market sectors mentioned, in which it can be wholly stated that, government intervention would prove to be a success when policies are implemented accordingly.

REFERENCES AND BIBILIOGRAPHY

DTI, Reform of UK Competition Regime, (1998) http://www.dti.gov.uk/News/Fair+Trading+magazine/index.htm.

DTI, Competition Act, (1998) http://www.dti.gov.uk/ccp/topics2/competition_act.htm

DTI, Competition Authorities, (1998) http://www.dti.gov.uk/ccp/topics2/authorities.htm

Lipsey, R.G., and Chrystal, K.A., (2004), Economics, Tenth Edition, Oxford Press.

Sloman, J., Ch 12.3, ‘Competition Policy’ in Economics, 5th Edition, Prentice Hall, Harlow. (SLC)

OFT, Fair Trading Magazine, various issues, available at: http://www.oft.gov.uk/News/Fair+Trading+magazine/index.htm

OFT, Market studies: http://www.oft.gov.uk/Business/Market+studies/cases.htm

OFT, Cartels, (2005): http://www.oft.gov.uk/Business/Cartels/default.htm

Hay, D., “Competition Policy” in T. Jenkinson (ed.) Readings in Microeconomics, 2^nd Ed., OUP, Oxford.

Davies, S., Coles, H., Olczak, M., Pike, C., and Wilson, C., ‘The Benefits from Competition’: some illustrative UK cases, DTI, Economic Paper No. 9, 2004. http://www.dti.gov.uk/economics/economics_paper9.pdf