Sunday, 4 October 2015

Is competition good for consumers?




A London cab aka a Hackney carriage,
Picture courtesy of wikipedia.org

When visitors come to London there are some things they would love to see and do. One of these is riding around the city in an iconic ‘London Cab’. The black cabs have long been one of the beloved icons of London....but perhaps they are no longer so loved by the city’s people. Has competition got anything to do with it? Does Uber play a role? 




These Hackney carriages could be considered as having monopoly power in the private car hire market in London. There is a reduction in consumer surplus under a monopoly (as seen in the diagram below), which translates to a loss in economic welfare. For people using ‘black cabs’ this means that they have to pay at least £2.40 for their journey, and that’s only the minimum cost. There is also the requirement that drivers pass ‘The Knowledge’. This exam, where all 25,000 streets and approximately 20,000 landmarks of London have to be memorised, is effectively a barrier to entry, as prospective drivers take on average two to four years to pass the test.

http://beta.tutor2u.net/economics/blog/unit-3-micro-monopoly-and-economic-welfare
As well as a net loss of consumer surplus, consumers may also have to accept a reduction in quantity supplied under a monopoly.
Diagram courtesy of beta.tutor2u.net
On the other hand Uber, which doesn’t require ‘The Knowledge’, can easily hire new drivers. This increased supply of workers means the firm can provide car journeys at a much lower price. Uber has thus introduced the element of competition into the market. It also provides its customers with many benefits, including paying for the journey in advance. Is competition like this good for the consumer?

Continuing with the example of Uber; competition gives the consumer a choice of goods and services. Since the companies involved have no guarantee of being the definite choice, they will be incentivised to improve customer service. Passengers appreciate having a profile of their Uber driver and are willing to pay for the feeling of security. Consequently there can be more innovation in competition. This is because companies want to develop their products and lower their costs of production. Hence consumers can possibly benefit from the lower prices offered by competitive firms. Competition can also benefit the consumer in markets such as the oligopolistic supermarket industry. Many consumers today are benefitting from non-price competition in the form of free coffee and newspapers from Waitrose or Clubcard points from Tesco.

Yet competition can also be bad for consumers. To see this we can look at the market for smart phones. Apple replaced Google maps on its iPhones with their own product and this move was made to distance the brand from its competitors and their products. However, consumers have lost out in the process, as Apple Maps can be simpler to use than Google Maps. Competition may also be bad for the consumer because marketing costs in a competitive market can be high. This is because firms need to differentiate their products to make them stand out. There is less money for R&D, so the consumer doesn’t benefit from as much product development. There are more firms in a competitive market which means that each firm is likely smaller and probably benefits less from economies of scale. Some firms also lend themselves to being monopolies, such as big pharmaceutical companies, and may not provide such good services if they were smaller and with fewer resources. Monopolies are also secure and know that any investment they make will come back to them. For example in the railway industry, where certain routes are franchised for limited amounts of time, owners could be unwilling to invest because it is not certain they would win the franchise again.

 I think competition is good for consumers. It forces firms in the market to develop the services they offer and there is greater consumer sovereignty under competition. Firms have to reduce the prices of their goods and services to stay competitive, thus accepting smaller profits. Above all, the consumer enjoys having a selection of products to choose from.  Simple evidence of how competition benefits the consumer comes from our earlier example of London cabs and Uber. Following Uber’s entry into the market, black cab drivers have begun offering deals via apps that mean reduced fares for passengers. So is competition good for consumers? Even though some may try to stop it (an example is the proposed restrictions* upon Uber in London), it looks like that’s the case.

Further Information + Reading

*        The proposed restrictions are subject to a 12 week public consultation period. Examples of these new restrictions are a mandatory five-minute wait time between ordering a taxi and pick up and a ban on showing cars that are available for hire.

    Is the Conservative London mayor trying to hinder the free market?