AQA Specification focus:
‘Both the short-run and long-run benefits which are likely to result from competition.’
Introduction
Competition in markets plays a crucial role in shaping firm behaviour, resource allocation, and consumer welfare. Its benefits differ between the short run and the long run.
Short-Run Benefits from Competition
Lower Prices for Consumers
In the short run, competition tends to push firms to reduce prices to attract customers. With multiple firms offering similar products, pricing above rivals risks losing market share. This price pressure directly benefits consumers through cheaper goods and services.
Allocative Efficiency
Allocative Efficiency: Occurs when resources are distributed such that price (P) = marginal cost (MC), meaning society’s resources are used to maximise welfare.
In the short run, competitive forces move prices closer to MC, improving allocative efficiency compared to monopolistic settings where prices often exceed MC.
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Image: insert image from https://commons.wikimedia.org/wiki/File:Economic-surpluses.svg
Identification: A clean vector diagram with an upward-sloping Supply curve and downward-sloping Demand curve, each labelled. Two shaded regions are visible, titled Consumer surplus and Producer surplus. It is the main image on the file page with the heading “File:Economic-surpluses.svg”, available in multiple resolutions.
Caption: A standard supply–demand diagram at competitive equilibrium highlighting consumer surplus and producer surplus. The shaded areas represent welfare gains when price equals marginal cost in a competitive market. Use it to visualise how competition improves allocative efficiency and immediate consumer welfare. Source
Incentives to Improve Quality and Service
Even in the short run, firms may enhance quality, customer service, and product availability to maintain or expand their market position. Differentiating on non-price factors provides short-term gains against competitors.
Productive Efficiency
Productive Efficiency: Achieved when firms produce at the lowest point on their average cost curve, minimising resource waste.
Increased competition pushes firms to use resources more efficiently, as inefficiency leads to higher costs and potential loss of market share.
Consumer Choice
With several competing firms, consumers benefit from greater choice. Even when products are similar, firms may compete on branding, customer support, or added services, leading to more diverse options.
Long-Run Benefits from Competition
Innovation and Dynamic Efficiency
Dynamic Efficiency: Efficiency gained over time through innovation, investment in technology, and improvements in productivity.
In the long run, firms are incentivised to invest in research and development (R&D) to gain a competitive edge. Technological progress reduces production costs, improves quality, and introduces new products, enhancing overall welfare.
Cost Reduction and Economies of Scale
Firms facing persistent competition seek ways to reduce costs to remain profitable. This often involves adopting more efficient production techniques. Where possible, they exploit economies of scale, lowering long-run average costs and passing savings to consumers through lower prices.
Two LRAC curves illustrating how average cost typically falls with output before reaching the minimum efficient scale (MES) and then rises with diseconomies. The diagram supports how competition drives firms to operate near MES, cutting unit costs over time. The source also discusses technology shifts and learning by doing, which extend beyond the syllabus requirement. Source
Long-Run Allocative Efficiency
In equilibrium, particularly under models such as perfect competition, the long-run outcome tends towards allocative efficiency, where firms earn only normal profits (just enough to keep resources in the industry). This ensures that scarce resources are used where they are most valued.
Greater Consumer Surplus
Consumer Surplus: The difference between the maximum price a consumer is willing to pay and the actual market price paid.
Sustained competition reduces prices and encourages innovation, increasing consumer surplus in the long run. Consumers enjoy both cheaper goods and higher-quality products.
Pressure on Monopoly Power
Competition acts as a constraint on monopoly power, preventing single firms from dominating markets indefinitely. In contestable markets, even the threat of entry can discipline incumbent firms, ensuring they behave more competitively over the long term.
Linking Short-Run and Long-Run Benefits
Short-Run Outcomes as Foundations
The short-run gains of lower prices, improved efficiency, and increased choice lay the groundwork for long-run benefits. For example:
Lower costs achieved initially may be reinvested into R&D.
Market discipline encourages firms to adopt practices that ensure survival in the long term.
Evolution Towards Efficiency
Over time, repeated cycles of competition encourage:
More efficient allocation of resources.
Ongoing innovation and product development.
A dynamic process where consumer preferences drive industry change.
Interdependence of Timeframes
Short-run competition enhances consumer welfare immediately, while long-run competition ensures that welfare gains are sustained and expanded. The two are therefore interdependent, with the short run influencing the future trajectory of industry performance.
Key Points for AQA A-Level Students
In the short run, competition improves prices, allocative efficiency, consumer choice, and quality.
In the long run, competition drives innovation, dynamic efficiency, cost reductions, and higher consumer surplus.
Competition reduces the risk of monopolistic exploitation and ensures firms remain responsive to consumer demands.
Both timeframes show how competition contributes to efficiency and welfare improvements in markets.
FAQ
In markets with homogeneous products, such as agriculture, the main short-run benefit comes from lower prices as firms are unable to compete on product features.
In markets with differentiated products, like clothing or restaurants, firms may compete on non-price factors such as branding, quality, and service, which also provides short-run consumer benefits beyond price reductions.
Even with competitive pressure, firms can make supernormal profits in the short run if:
Demand is high relative to supply.
They have temporary cost advantages.
Barriers to entry prevent immediate new competition.
However, in the long run, these profits tend to be eroded as new firms enter and competitive forces intensify.
In the short run, consumer surplus rises mainly because prices fall closer to marginal cost.
In the long run, consumer surplus grows further as innovations, cost reductions, and product improvements expand choice and enhance value for consumers. Thus, the gain is both in price savings and in better-quality goods and services.
MES represents the lowest level of output where long-run average costs are minimised.
Competition pushes firms to operate close to MES to survive. This reduces inefficiency, lowers prices, and benefits consumers. Firms unable to achieve MES often exit, leaving more efficient producers in the market.
In contestable markets, the mere possibility of new firms entering disciplines incumbent firms.
They may keep prices low, invest in efficiency, and innovate to deter entry. This means consumers can still enjoy benefits of competition even in markets with few firms, as long as entry and exit remain relatively easy.
Practice Questions
Define allocative efficiency and explain why competition in the short run can help achieve it. (2 marks)
1 mark for a correct definition: Allocative efficiency occurs when price (P) equals marginal cost (MC).
1 mark for recognising that competition forces firms to lower prices towards MC, improving resource allocation.
Discuss two potential long-run benefits of competition for consumers. (6 marks)
Up to 2 marks for identifying and explaining each long-run benefit (max 4 marks):
Innovation and dynamic efficiency (firms invest in R&D, leading to better quality and new products).
Economies of scale and cost reduction (lower average costs leading to lower prices).
1 mark for linking these benefits to improved consumer welfare (e.g., higher consumer surplus).
1 mark for clear written communication, logical structure, and use of economic terminology (e.g., consumer surplus, dynamic efficiency).
