A competitive market implies many firms and a freedom of entry and exit and many firms seeking to attract customers. On the one hand, competitive markets will create an incentive for firms to develop new and better products. However, the lack of supernormal profit may make investment in research and development difficult.
How competitive markets promote innovation
1. Attract customers In a competitive market there are many firms, therefore to succeed firms have to work very hard to attract customers through innovation and developing better services/products offering more variety and choice e.g. the internet is quite competitive but firms offer different services and products.
2. Without innovation may go out of business. If firms are inefficient (uncompetitive) then they can easily make a loss, therefore, there is an incentive to innovate new ideas and products to attract customers e.g. telecommunications – mobile phones with diverse features and accessories and in a monopoly there is less incentive because they have an “easy life”.
3. Innovation is the nature of competitive markets. The model of perfect competition implies perfect information, but this is not realistic for the real world. In practice, if firms develop some new innovation they will gain, at least, temporary competitive advantage and so the incentive to develop new products and services is there.
How competitive markets may hinder innovation
1. Lack of profit for research and development. If markets are too competitive, profits will be low, therefore firms cannot spend on research and development, to develop new products, therefore innovation will be low.
2. Scope for copying innovation in competitive markets creates disincentive. Competition implies a good exchange of information between customers, therefore, new products could be copied (in perfect competition this will occur), so to innovate you need an incentive e.g. patent law as a barrier to entry, therefore this is not competition.
Conclusion
Overall competition can promote innovation but is not always the case in reality as a lot has come from monopolies e.g. Microsoft and drug companies.
A competitive market involves many firms supplying a good and the consumer will be aware of the lowest prices and best goods. Therefore to succeed firms have to be efficient.
Definitions for reference:
- 1. Innovation (noun) – 1. something newly introduced, such a new method or device
- 2. A competitive market is a market with many buyers and sellers, free entry and exit i.e. new firms must be able to easily enter It and the firms are ‘price takers’ e.g. they can’t set prices to what they want but they have to accept the market equilibrium price where supply equals demand.
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