competition and its role in market economy

Introduction
1 Market structure and competition
1.1 Competition and price
1.2 Market structure
2 Competition policy
2.1 Competition and the policies
1.2 History of competition policy development
1.3 Objectives of competition policy
1.4 The role of compensation policy in economic development
3 The level of competition in Russia
Conclusion
Literature list

competition and its role in market economy

Merging of two or more competing firms is beneficial in that it may increase their market share significantly, and thus achieve greater economies of scale. In this way, competition can also be reduced. Firms may also merge hoping to achieve monopoly power. The larger firm that results from a merger would have greater control over market supply and price than a few smaller firms.The triple equality for economic efficiency:P = MC = minimum ATCOligopolies do not satisfy this. Many oligopolies sustain nice economic profits year after year.Productive Efficiency and Allocative Efficiency:Oligopolies often sustain economic profits. They produce where P > minimum ATC so they are not productively efficient They produce where P > MC so they are not allocatively efficient. This means that inoligopolies, firms neither produce in the least costly way nor produce the right amount of a product according to society's wants.At this price, output is below the output at which minimum ATC is reached. There is an underallocation of resources. Oligopolists are less desirable than pure monopoly because government usually regulates pure monopoly.The concept of Monopolistic Competition is concerned with the common form of a market and its competitions. Monopolistic Competition is present in various industrial sectors such as apparels, restaurants, footwear, food and in the service sectors as well. Characteristics of Monopolistic Competition: Relatively Large Number of Sellers: Small Market Shares: Each firm has a small percentage of the total monopolistic market and thus has only limited control over market price. No Collusion: A relatively large number of firms will not combine to restrict outputs and set prices. With so many firms, collusion is almost impossible because it is too easy for one firm to cheat and charge the lower price. Independent Action: Each firm is independent and can determine its pricing policy without considering its rivals. eg. A firm could moderately increase its sales by cutting its prices, but that would have no significant effect on its competitors sales. Differentiated Products:Product Attributes: product differentiation may entail physical or qualitative differences in the products themselves. Real differences in functional features, materials, design, and workmanship are the vital aspects of product differentiation. Service: Service and the conditions surrounding the sale of a product are forms of non-price product differentiation too. Location: Accessibility of stores that sell certain products or placement of products in stores eg. products at eye level would have an advantage over those that are not. Brand Names and Packaging: Brand loyalty and packaging can affect demand. ie. Apple's iPhone. It's pretty much the same as any other phone. It has touch screen capability, can surf the web, can listen to music, but the apple brand as well as advertising makes it a big hit on the market of cell phones.Some Control over Price: Producers can charge extra for extra features, etc. Generally, firms are "price makers" since each firm owns such a small percentage of the total market; if a firm changed the pirce of their product, there would not be much of an effect on the market.The firms in monopolistic competition will differentiate their products and make them more appealing to the customers in order to maximize their profits.Equilibrium in the long-run monopolistic competitive market:Let us suppose that Firm A formulates a strategy to reap higher profits. The monopolistic competitive Firm B duplicates this strategy. As a result, there is a decline in the price level. In the long-run, the price will reduce to the level where economic profit is zero. Long-run equilibrium will be acquired at this point. Drawbacks of the monopolistic competitive markets:Monopolistic competitive markets are inefficient in handling the cost of the regulating prices of each sold good. This is because the output of the concerned firms involves substantial production costs. Such markets are known for extensive promotions of advertisements for the sake of developing brand names, making the consumers unnecessarily spendthrifts. Moreover, this also increases the expenditure on unnecessary advertising-related activities . Monopolistic Competitive Industries: Shoes -Nike, Addidas, Reebok; Jewelry; Asphalt paving; Signs; Bottled water; ice cream-Breyers, Tom & Jerry; Mobile Phone- Nokia, Samsung, Sony Ericcson. Picture 1.2.4 – Price and Output in Monopolistic Competition 1) The figure on the left shows economic profit. 2) The quantity supplied is determined by the point where MC and MR intersects, and extends the vertical line upward to find the price that the firm would charge.3) Because price is above ATC, this firm is earning economic profit4) Economic profit attracts new firms to enter. Because a monopolistic competitive industry has low barrier of entry, eventually, the firm will only earn a normal profit in the future5) Demand of the firm will shift to the left and become more elastic because there are more substitutes6) After adjussting price and demand, the firm loses its economic profit.Monopolistic Competition and Efficiency Productive efficiency is P= min ATC Allocative efficiency is P= MCPicture 1.2.5 - Efficiency of monopolistic competitionA monopolistic competition industry has neither productive nor allocative efficiency:A. Marginal revenue curve will never coincide with D=AR=P in monopolistically competitive market, Demand is relatively elastic. Products are somewhat substitutable.B. Firms produce at a point where P>MC, meaning that resources are underallocated; not allocatively efficient C. Firms do not produce where P= min ATC; therefore, no productively efficientD. In the long run, MC industries will only earn a normal profit. P= ATC (but not minimum ATC)E. This is also caused by relative ease of entry and exitWhen profits are earned, more firms will enter (easy to enter/ exit) and demand for an individual firm decreases (shifts to the left). This causes an individual firm's profits to decrease. Demand curve becomes more elastic. When there are losses, firms will leave (easy to enter/ exit) and demand for an individual firm increases (shifts to the right). This causes an individual firm's profits to increase. Demand curve becomes less elastic.Product differentiation creates excess capacity.A. Excess capacity means that fewer firms operating at capacity could supply the industry output.B. Excess capacity is the gap between the minimum ATC output and the profit-maximization output, indicating that the firm is operating below optimal capacity (plant and equipment that are underused because firms are producing less than min ATC output.)C. The greater the product differentiation, the greater the productive inefficiencyD. The industry is overcrowded by firms to operate at its optimal capacityIf firms is able to produce product at P = min ATC, they could have same amount of product at lower price2 Competition policy2.1 Competition and the policiesCompetition and the policies that help to underpin it are among the most important elements of modern regulation. Almost every government around the world relies on competition to deliver a more efficient economy and help drive economic growth. Most of those governments are also committed to developing the policy tool kit that lets them harness the process of competition and stop those who might seek to abuse it. Competition is not necessarily a natural state for many markets. In some, such as gas, water, and electricity markets, the need for major infrastructure impedes competition. But in other services and goods markets, policies that promote competition can be used to encourage fair play among firms, to shed light on otherwise murky pricing and contracting practices, and to open up opportunities for small- and medium-sized enterprises to grow. Competition and the competition policy tool kit can also be used to eliminate corruption and rigged bidding processes and thus maximize the value of public expenditure.Before looking at competition policy, first need to distinguish it from competition itself. Although this may appear a little contradictory, it is important to identify what each policy area does and what it does not do. It is also important because of language. Many countries have in fact had what are now called competition policies for hundreds, if not thousands, of years. These market-regulating laws and rules were designed to ensure a form of fair play in the marketplace. Market rules have existed for as long as markets and long before what is called the market economy. 1.2 History of competition policy developmentThe first modern expressions of what it is called competition law started in North America with the Canadian Combines Act of 1889 and the (US) Sherman Antitrust Act of 1890. These laws resulted from a revolt of the rural and urban poor against the power of what were called the industrial trusts, which controlled large parts of commerce through collusion and abuse of their huge economic power. The laws were also passed to head off more populist and radical responses to an increasingly abusive form of industrial capitalism. The United States still calls its laws antitrust laws and the countries quickest to follow the North American lead were also heavily agricultural economies suffering under the yoke of a small number of very powerful firms. Timeline of competition laws: 1889 — Canadian Combines Act passed (Canada)1890 — Sherman Antitrust Act passed (United States)1911 — Standard Oil and American Tobacco Co. split up using the Sherman Act 1914 — Clayton Antitrust Act passed (United States) 1915 — Federal Trade Commission formed (United States) 1957 — Treaty of Rome established (European Economic Community) 1976 — Hart-Scott-Rodino Antitrust Improvement Act (United States) investigated mergers for antitrust activities 1980 — United Nations Conference on Trade and Development (UNCTAD) adopted a set of policies to tackle restrictive business practices 1982 —American Telephone & Telegraph (United States) split up because of an antitrust suit filed in 1974.The origins of modern competition law were, thus, a response to abuse by firms. However, they were also framed by the need to ensure that the economy used its resources as efficiently as it could. Monopolies were seen as wasteful and as closing off opportunities for rival firms to sell their wares. The desire for efficiency and to promote entry and innovation have underpinned much of the efforts to inject more competition into economies ever since.The proliferation of modern competition law only really occurred after World War II. Although, previously, many countries had some market-regulating rules (most European countries have had such laws since the Middle Ages), they tended to be biased in favour of the largest and most powerful firms and guilds and against the consumer and smaller players. One of the reasons for the increase in competition policy after World War II was the role that anticompetitive practices played in the run-up to the war itself. In both Germany and Japan, cartels were forced on the economy as part of war preparations. In the immediate after math of the war, the occupying powers broke up these cartels and wrote competition laws in both Japan and Germany. 1.3 Objectives of competition policyAn effective competition policy is an important underpinning of an efficient economy. To date, there is no universally agreed approach to competition policy. Different approaches are used by different countries. Some have extensive legislation covering merger review, dominance and anti-competitive practices, while others have basic price surveillance legislations. Competition policy should, therefore, be understood in a broad sense, and viewed as comprising not only antitrust policy, but also other policies that have an impact on market structure, business behaviour and economic performance. It should also be understood in a dynamic context. Indeed, in the context of trade policy a dynamic argument for protection is the infant-industry case, where the costs of production decline in the future. Krugman (1984) highlights this case as one where protection from competition, in this case imports, expands output to the point where the protected industry becomes internationally competitive. Increasingly, the competition policies of many governments aim to promote dynamic as well as static efficiency gains, for example in the approach that they take to intellectual property licensing issues. Despite the different approaches used by countries, all competition policies have the ultimate common goal of maintaining and encouraging competition. However, in some cases the objectives as stated in the legal instrument are very broad (World Bank and OECD (1999); CUTS (2003). Nevertheless most of the legal instruments that were developed in the 1990s have the objective of ‘promoting’, or ‘encouraging’ competition.This is a marked shift in the intent of the instruments developed prior to the 1980s. A good example of this shift is the case of India, where its 1969 Act aimed at the “prevention of concentration of economic power that is or that may lead to the common detriment”. The 2002 Act has various objectives, including to prevent practices having an adverse effect on competition, to promote and sustain competition in markets, to protect the interests of consumers, and to ensure freedom of trade.Some further examples of objectives from different competition policy instruments are stated below:maintenance of the competitive process or of free competition;freedom of trade, freedom of choice and access to markets;freedom of individual action;securing economic freedom;lessening the adverse effects of government intervention in the marketplace;prevention of abuse of economic power;achievement of economic efficiency.As noted above, a competitive market may not deliver an equitable result. One view would be to include equity as an objective of competition policy. While understandable from the point of view of governments concerned with social justice, the reality is that broad and ambiguous mandates give rise to the possibility of inconsistent outcomes. In the extreme case, the absence of clear and concise objectives can lead to incoherence and perhaps the political capture of the competition authority.The number of countries with competition policies has been steadily increasing. Most developed countries have had some type of competition legislation in place for some time, so these new countries are predominantly developing countries. This is a positive development. It should be noted, however, that developing countries do not form a homogenous group. There are fundamental economic differences between them and one would not expect a high degree of homogeneity in their approach to competition policy. Yet at the same time there are a number of similarities, or core principles.The return of competition policy as part of international policy making is driven by continuing reductions in trade barriers and the increasing fragmentation of the production structure of the world economy. Both of these developments have taken place in the context of dramatic changes in information and transport technology, and the growth of the service sector in the world. These developments have contributed to a more competitive global economy and a very different trade policy environment compared to the immediate post-World War II period. A key issue is whether the benefits of continued trade liberalization can be nullified by the anti-competitive actions of private firms, despite an increasingly competitive global environment. Or, conversely, whether trade policy instruments can be used as an effective remedy against anti-competitive behaviour. The discussion that follows of how competition policy can enhance the benefits of trade liberalization distinguishes among three scenarios in an open economy where anti-competitive practices may exist: where a domestic firm engages in anti-competitive practices in a domestic market; where a foreign firm engages in anti-competitive practices in a domestic market; and where foreign firms engage in anti-competitive practices in international markets that affect prices in a domestic market. The starting point for the analysis is an overview of the basic concepts of market structure. This is followed by a discussion of how competition policy addresses selected market failures. Finally, some conclusions are drawn on the interaction between trade policy and competition policy.Competition law is used to address three main situations:Anticompetitive agreements, where two or more firms agree among themselves to fix prices, limit production, divide markets up geographically, or rig bids when tendering for government contracts. Abuses of dominance or exclusionary behavior, where one firm is so powerful it can act without thinking about its rivals or can act to exclude its rivals. Abuses of dominance or exclusionary behaviour can include predatory pricing (pricing below cost to drive competitors out of a market and then raising prices once they have gone), tying up distribution networks to exclude competitors from the market (not allowing distributors to carry competitors’ products), and denying competitors access to essential facilities (stopping a shipping company landing goods at a dock). Merger-control regulation, where firms that want to merge are reviewed to ensure that their deal is not likely to reduce competition significantly. Merger-control regulation is aimed at ensuring that mergers do not lead to too much market concentration, which may lead to abusive behaviour. This type of law is unusual in that it is pre-emptive — economists would say ex ante — an authority can block a merger before it happens. Anticompetitive agreements and abuse of dominance controls are reactive (ex post) in that the events have already occurred.The object of competition law is generally twofold: first, to ensure that anticompetitive behaviour and agreements are restricted with the object of, second, ensuring that normal market dynamics occur. Thus, competition policy is largely intended to cure abuse sin the marketplace (cartels and barriers to rivalry) or to ensure that future abuses do not occur (by blocking mergers).To complicate matters, competition policy includes things like advocacy and coordination with government departments that go beyond competition law. Competition law is the adoption of legislation to prohibit anticompetitive conduct by the private sector that reduces competition in markets. Competition law and policy are part of a tool kit that all governments need and most use to deal with the modern world economy. Other measures include trade, investment, and general government policies that affect competition within an industry or market. Some industries, particularly those that used to be run by the state or are “natural monopolies,” have sector-specific regulation (i.e., a specific regulator keeps them in check and generally tries to introduce competition into the market gradually).1.4 The role of compensation policy in economic developmentCompetition policy is increasingly acknowledged as an instrument that promotes economic development as witnessed by the increasing number of countries that enact and enforce competition laws and by the recommendations international, regional and global organisations issue to encourage countries to adopt a competition law and policy.It is important to star explaining why trade liberalisation, deregulation and privatisation are necessary, but do not provide sufficient elements to ensure the efficient functioning of markets.