Competition in an economic sense is the rivalry between two companies that arises when they try to win a third party as a customer.
What is competition?
Competition in an economic sense is the rivalry between two companies that arises when they try to win a third party as a customer. Competition is believed by several economists to encourage innovation, productivity and efficiency. Critics may argue that the focus on competition leads to increased volatility since it can drive competitors to potentially outspend each other in an attempt to secure a dominant market position. This can take a toll on the budget and leave a company overexposed which makes it more vulnerable to market fluctuations, hence leading to layoffs in case the company suffers an economic setback.
Different types of competition
Adam Smith described competition in his 1776 book “The Wealth of Nations” as the allocation of resources to their most highly valued uses and encouraging efficiency. Later economists began to distinguish between perfect and imperfect competition, whereas perfect competition only exists in theoretical models.
Since then, three models of economic competition have become broadly used:
- Direct competition: In this scenario, products that have the same function compete against each other. For example, two companies manufacture tractors and one company introduces a new feature to their product. The other manufacturer responds by introducing the same feature to their product.
- Indirect competition: Here, the competition is between two products that have a similar function and could ostensibly be substituted for one another, like butter and margarine.
- Budget competition: This model is based on the idea that several entirely different products compete for the customer’s money. This can happen between a video game console and a bicycle, seeing as both are geared towards being used by a customer in their free time. And since consumers have a limited budget and limited time, only one product can be successful.
Another way in which companies compete with one another is for funding from investors in the form of equity or debt. Most companies have to bring in outside investment in order to realize projects more quickly and efficiently.
Some companies also utilize internal competition. It is supposed to keep employees on edge and encourage productivity and innovation, in theory. However, it can lead to a heightened level of fear amongst employees as well as antagonizing them. Internal competition can be subtly created by giving different departments tasks that overlap, spurring them to outdo each other. Another common example is between sales representatives. Here, performing well is often incentivized by bonuses only awarded to the top salespeople.
Regulation & Criticism
Over the years, competition has become increasingly regulated. States often place restrictions on how companies are allowed to compete. This serves to keep more different companies in business, ensuring freedom of choice for consumers.
Critics have argued that competition has a lot of negative side effects on the environment, society and education.
One of the main critics of competition was Karl Marx. He posited that “the capitalist system fosters competition and egoism in all its members and thoroughly undermines all genuine forms of community.” According to Marx, competition separates workers and keeps them occupied with each other instead of organizing effectively.
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Disclaimer: This overview is for informational purposes only and cannot be counted as legal advice.