Question

Explain when and why the existence of competition matters for efficiency according to Vickers. Relate your discussion to the insurance, reputation, and ratchet effects.

Answer 1

John Vickers, a British economist vide his studies discussed the effect of competition in attaining economic and productive efficiency. The fundamental theory of welfare economics discusses the concept of ‘competitive equilibrium’ where markets are available for all the commodities and there is a condition of existing Pareto efficiency, a state in which no one can be made better off without the others being worse off. According to Vickers, the following are the effects on competition on productive efficiencies

· It helps in sharpening the incentives to avoid sloth and slack and thus helps in maintaining organizational efficiency in a firm.

· Competition causes the efficient organizations to prosper over inefficient one’s and it plays a key role in generating aggregate efficiencies.

· Competition to innovate is the major source of gains in the productive efficiency over time.

· The productive efficiency occurs when the equilibrium output is supplied at a minimum average cost, which occurs in a competitive market.

· Competition always helps in focus on better consumer satisfaction which could improve the productive efficiency

· In short and long run, the price is equal to the marginal cost and thus allocative efficiency is achieved.

· For a competitive market, productive efficiency occurs when the equilibrium output is supplied at minimum average cost, which is true for a long run competitive market.

· A competitive market always forces the firms to reduce their cost of production to achieve more profits. This leads to minimum wastage of resources and attainment of static and dynamic efficiency.

Interest, Reputation and Ratchet Effects

· Ratchet effect in simpler economic terminology states that when the prices have been raised to meet the demand in the market, the effect do not always reverse when the demand falls. Thus, it refers to escalation in production or prices that tend to self-perpetuate.

· In a market, there is a tendency to inefficiently low quality which the mechanism of reputation may or may not overcome. Thus, regulating the product quality or supplier quality san sometimes overcome this problem.

· As the quality regulation, the interest of the customers and suppliers can diverge even if there is effective competition between those suppliers.

    Thus, according to Vickers, competition induces three major chages ie; changes and improvements in the internal organization, inducing a selection process and attainment of technological progress which improves the efficiency.