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Competition and
Concentration
Concentration writ large
• There are hundreds of millions of business
and companies in the world
• Yet the largest 1000 companies produce
80% of the worlds industrial output
• In the US, about 1200 companies produce
more than 50% of the GDP.
The coexistence of competition and
concentration
• The degree of economic concentration
depends on the ability of firms to ward off
competition
• Competition impinges on profit margins
• Competitive forces limit what a firm can do
and shapes what it is driven to do
Businesses hate competition
but it forces them to change
Three-fourths of 531 corporations
surveyed identified economic pressures
from competitors as one of the primary
factors motivating their restructuring
efforts.
Example of Cutting into Profits
• BEIJING/HONG KONG (Reuters) - China Mobile (0941.HK), the
world's largest mobile carrier, faces a further squeeze on profit
margins as competitive pressures intensify and an expensive
buildout of a new, untested 3G network weighs. The firm, which had
493 million users at the end of June, on Thursday posted its slowest
interim profit growth since it listed in 1997 and said it expects
average revenue per user (ARPU), a key barometer of earnings, to
slide in the months to come. Like smaller rivals China Unicom
(0762.HK) and China Telecom (0728.HK), which now compete with
a full range of services after a major Beijing-ordered restructuring
last year, China Mobile is aggressively moving into poorer and less
profitable rural areas as urban markets become saturated."We can't
preserve such a (high) margin for the long term," Chief Financial
Officer Xue Taohai told a media briefing.
Outline
1. Businesses must compete for profits, and they do so by
manipulating the determinants of their own profit rates.
2. Business competition takes three principal forms: (a)
price competition) (b) breakthroughs; and (c) achieving
monopoly power.
3. For all three types of competition, firms must invest to
compete.
4. Because firms must invest to compete, competition is
inherently dynamic:
5. The competitive scramble produces different profit rates
among firms; but, conversely, it also tends to equalize
profit rates
6. The dynamics of competition produce both economic
concentration (which results when large firms displace or
acquire smaller firms) and decentralization
In order to survive competition,
firms manipulate the determinants
of profit rate
(Pzef )  (Pm m)  w
r
1
Pc u c
 
Price Competition
• Firm has 10 machines. It makes profits of
$1000 and each machine costs $1000 -->rate
of profit =10%
• Now what is the profit rate per hour if it can
use each of its 10 machines only to 50%
capacity?
• Since each machine is only being used to
50%, the potential profit rate is being cut by
half.
But.. there is a remedy..
(Pzef )  (Pm m)  w
r
Pc 1 u c
 
There is a relationship between the Price of the output and the capacity
Utilization.

We know from the law of demand that if the price is lowered, more output can
be sold
A ha..
• Firm can increase output and increase u
by reducing Pz.
• But, the overall effect on profit rate is
unclear: If the rise in demand is not very
large, then u will not rise sufficiently to
offset negative effect on r from reduction in
Pz.
• This is linked to a notion that we have
heard of: elasticity
Elasticity and Price Competition
• Will price competition be more or less
when the good has an elastic demand or
an inelastic demand?
• Think about the goods you know and see
whether this matches up to reality...
The notion of unit cost and profit
(Pzef )  (Pm m)  w
r
k
Rearranging this term, we have
Pz=(Pm*m)/z +w/z+rk/z
Price= unit material cost+unit wage cost+unit profit
Unit profit is sometimes called markup
The movement towards average
profits
• Consider an industry where Pz is so high that
rk/z is higher than in other industries,
• Other firms will enter, reducing Pz and
competing away
• So there is a tendency for money and
investment to flow into higher profit industries,
lowering the relative profit there and increasing
the relative profit in others.
• Tendency to equalize profit rates across
industries!
Breakthroughs
• A breakthrough is something new—a new
product, a new way of recruiting labor, a
new technology, or anything innovative
that gives one firm an advantage over its
rivals.
• Metaphor: Price competition like trench
warfare, Breakthroughs are like tanks
Examples of breakthroughs
• New, more productive
technology
• New product
• Better quality product
• Rearrangement of
production
• Use of different and
more productive (or
cheaper) labor
(Pzef )  (Pm m)  w
r
Pc 1 u c
 

Third form: Reduce Competitive
Pressures
• Obtaining Monopoly Power You can
obtain proprietary rights and patent rights
(software/medicine)
• This could also happen because of
increasing returns to scale (remember?)
• Some industries have large barriers to
entry—technical secrets, large exclusive
marketing arrangements, high initial
investments etc.
Oligopoly/Cartelization
• Cartels—illegal, but common—regulate
the production and pricing of output
• Sometimes this agreement is tacit and not
explicit– firms then do not cut prices for
fear of a price war and instead compete on
other dimensions (sales for example)
Quote from...?
• People of the same trade seldom meet
together, even for merriment and
diversion, but the conversation ends in a
conspiracy against the public, or in some
contrivance to raise prices.
Investing to compete..
• All three forms of competition force firms
to put away some profits in order to
compete in the next period
• In order to maintain or increase profit rate,
firms invest (in new technologies, buying
privileges etc.)
• The idea is to obtain dynamic competitive
advantages (consider fig 11.2)
How to decide when to invest
• Let i refer to the cost of buying new
equipment, hiring new scientists etc. We
can think of this as the cost of borrowing
money from the bank for this purpose
(sometimes it is called the interest rate)
• Let re be the expected rate of profit on the
investment.
• Then firm should invest if re >I
• re depends on sentiment!
Interest rates and investment
• Now this means something quite
interesting. The amount of investment and
the amount of growth in the economy
could depend on not on what the firm
thinks it could get in terms of return, but
also the interest rate.
• If interest rates are low, incentives to
invest are higher and probability of
growth/competition are higher
Equalization of Profit Rates?
There is a tendency for funds to flow into industries where profit rates are high
lowering relative profits..
How much concentration in each
industry though?
• Economic Concentration: the extent to
which the economic activity of an industry
is conducted by a large number of firms.
• In the previous diagram, the supply might
be increased by the entry of one firm, or
10,000 firms.
• Answer: it depends on the characteristics
of the industry
Advantages of Size
•
•
•
•
•
Size allows you to:
A) Spend more money on breakthroughs
B) Market more effectively
C) Lobby more effectively for advantages
D) Become larger by buying out
competitors
• E) Enter new and connected markets
more effectively (consider Time Warner)
But in certain industries...
• A) lower barriers to entry
• B) Non increasing returns to scale
• C) Newer industries so not so much
entrenched political hold
• D) New and improved technologies are
easier to come by and therefore displace
established companies
• E) International Competition has increased
On balance
• Concentration has decreased marginally in
the US since 1980. It is a more
competitive economy.
• Yet, many industries in which there is high
concentration.