Published Jun 29, 2020 In an economic context, competition describes a situation where consumers have the opportunity to choose between different products or suppliers. There are five factors that influence competition: product features, the number of sellers, barriers to entry, the availability of information, and location. Each of these factors has an effect on the choices consumers can make, which means they change the attractiveness and availability of substitutes. We’ll look at each of the five factors in more detail below. Product features describe distinctive attributes of a product that set it apart from other products. If goods or services become more differentiated, the level of competition in the market tends to decrease, and vice versa. The reason for this is that unique features make products less interchangeable, which reduces the number and attractiveness of substitutes available. Meanwhile, if all products look alike (i.e., are homogenous), it’s much easier for consumers to switch from product to another. To give an example, imagine three ice cream trucks that are located right next to each other. Now, let’s assume that the only difference between the ice cream they sell is the flavor (i.e., the flavor is a product feature). If truck A sells vanilla ice cream, truck B sells strawberry, and truck C sells chocolate flavor, their products are differentiated, and competition is low. Simply put, in that case, people who like strawberry don’t have much choice but to go to truck B. By contrast, if all three trucks sell strawberry ice cream, their products are homogenous, and strawberry enthusiasts can choose between three different suppliers. This results in a higher level of competition. The number of sellers directly affects the number of choices consumers can make. If the number of suppliers who sell the same or a similar product increases, the level of competition rises too. By contrast, if the number of sellers falls, the industry becomes less competitive. In the most extreme case, a market with only one single seller doesn’t have any competition at all because consumers cannot choose where to buy their products. To illustrate this, let’s revisit our three ice cream trucks. If we assume that all of them sell the same product, consumers have three equal options. In that case, each of the three sellers gets a third of the market share. Now, if two additional trucks set up shop at the same location, the consumers get two more choices, and the trucks have to split the market by five. In that case, each seller has to prevail against four other trucks instead of just two, which means the competition increases. By contrast, if all but one seller go out of business, the remaining truck can serve the entire market, and there is no more competition. Barriers to entry describe how easy or difficult it is to enter or leave the market. High barriers to entry (e.g., high initial investments, complicated regulations) can prevent new sellers from entering the market, which keeps the competition low (see above). On the other hand, if new sellers can freely enter or exit the market, there is less protection for existing sellers, and competition increases. To see how that works, we can revisit our three ice cream trucks. Now, assume they all had to get a permit before they could sell ice cream. To make things worse, let’s say this permit costs USD 10,000 and takes two years to obtain. In that case, it’s quite expensive and time-consuming for new sellers to enter the market. As a result, the three existing sellers don’t have to worry about new competitors anytime soon. Without those regulations, anyone with a freezer can sell ice cream, and the competition can significantly increase in a matter of days (e.g., on a hot summer day). In this context, the availability of information mainly refers to how difficult it is for consumers to find and compare prices. If it is easy for them to compare offers and prices across competitors, the level of competition increases, and vice versa. The reason for this is that a lower price increases the attractiveness of a competing product (i.e., substitute), but only if the consumers know about it. To illustrate this, assume our three ice cream trucks have to list all their prices on a large board at the beginning of the street. This makes it easy for buyers to compare prices and pick the most competitive offer. By contrast, if none of them actively communicate their prices, consumers have to go and ask every single one of them how much their ice cream costs before they can pick the best offer. Most consumers probably won’t do that, because the opportunity cost of doing so would be too high (i.e., it would not be worth their time). Finally, the location of the sellers can have a significant impact on competition. On the one hand, larger distances between sellers reduce competition because they make it more tedious for consumers to switch between suppliers. On the other hand, the location of a store or business can be a competitive advantage if it allows sellers to reach more potential customers. Imagine all three of the ice cream trucks in our example were located on a different block. In that case, buyers would have to do quite a bit of walking to compare all offers and pick their favorite. At the same time, the truck located closest to the beach would probably get the most customers, because people wouldn’t want to walk several blocks just to get some refreshing ice cream. Competition describes a situation where consumers have the opportunity to choose between different products or suppliers. There are five factors that influence competition: product features, the number of sellers, barriers to entry, the availability of information, and location. Unique product features and the availability of information influence the attractiveness of substitutes, whereas the number of sellers, barriers to entry, and the location affect their availability.1. Product Features
2. Number of Sellers
3. Barriers to Entry
4. Availability of Information
5. Location
Summary
Microeconomics