Essential Schumpeter: The Nature of Competition

Summary

Joseph Schumpeter challenges traditional views on competition, arguing that it’s not about the number of firms in a market, but how easily new firms can enter and disrupt existing ones. Using a comparison between two islands selling kiwi popsicles, Schumpeter shows that even with fewer firms, the island with fewer barriers to entry is more competitive. The key to fostering innovation and competition, he argues, is reducing obstacles for new entrepreneurs. Schumpeter’s perspective shifts the focus from market concentration to market openness as the true driver of economic progress.

Takeaways

• 😀 Schumpeter challenges traditional views on competition, suggesting it's not about the number of firms, but how easily new firms can enter the market.
• 😀 Traditional economics often assumes more firms in a market equals greater competition, but Schumpeter disagrees with this view.
• 😀 On the eastern island, competition is limited due to government-imposed barriers, such as licenses and expensive regulatory requirements, which allow existing firms to charge higher prices.
• 😀 In contrast, the western island has fewer restrictions, which allows new firms to enter the market easily and compete with the existing two firms.
• 😀 Schumpeter emphasizes that competition is about the ability for new firms to innovate and challenge incumbents, not the number of firms in a market.
• 😀 Barriers to market entry prevent entrepreneurs from competing, limiting innovation and keeping prices high.
• 😀 On the western island, the low barriers to entry lead to price competition, forcing the two firms to innovate with new products and services.
• 😀 Schumpeter's key argument is that markets with low entry barriers foster innovation and competition, leading to better products and services for consumers.
• 😀 The concept of 'creative destruction' is inherent in Schumpeter's view, where new firms disrupt existing market structures and force incumbent firms to adapt.
• 😀 Schumpeter's ideas are still relevant today, showing the importance of removing regulatory barriers to foster competition and innovation in modern economies.

Q & A

What is Joseph Schumpeter’s view on competition?

Schumpeter argued that competition isn’t simply about the number of firms in a market. Instead, it is about the ease with which new firms can enter the market and challenge existing firms, driving innovation and improvement.

How does Schumpeter’s view of competition differ from traditional economics?

Traditional economics measures competition by the number of firms in the market. In contrast, Schumpeter emphasizes that true competition arises from the ability of new firms to enter and disrupt existing businesses, not from merely having many firms present.

What example does Schumpeter use to illustrate his point on competition?

Schumpeter uses the example of two islands selling kiwi popsicles. The eastern island has ten firms, while the western island has only two. Despite having fewer firms, the western island is considered more competitive because new firms can easily enter the market, which forces the existing firms to innovate and lower prices.

Why does the eastern island have less competition, according to Schumpeter?

On the eastern island, the government controls the number of firms allowed to sell kiwi popsicles through a licensing system. The lengthy and costly application process, along with other regulatory restrictions, limits new firms from entering the market, resulting in less competitive dynamics.

How does the regulatory environment on the eastern island affect pricing?

Due to government-imposed restrictions and the limited number of firms, the firms on the eastern island can charge higher prices for kiwi popsicles. The lack of competition allows these firms to maintain higher profit margins.

What role does innovation play on the western island?

On the western island, the lack of restrictions allows new firms to enter the market easily, which forces the existing two firms to innovate to stay competitive. They introduce new flavors, improve services like home delivery, and keep prices low to remain attractive to consumers.

What does Schumpeter believe is the real measure of competition?

Schumpeter believes that the real measure of competition is the ability of new firms to enter the market, innovate, and challenge established firms. Barriers that prevent new entrants from disrupting the market hinder true competition.

What is meant by 'creative destruction' in Schumpeter's theory?

Creative destruction refers to the process where new innovations and firms disrupt and replace existing businesses and technologies. Schumpeter argued that this constant cycle of disruption is essential for economic growth and progress.

How does the open market in the western island influence business behavior?

The open market on the western island forces existing firms to continually innovate and improve their offerings to maintain their position. The ease with which new competitors can enter the market compels the firms to stay competitive by lowering prices and offering new products and services.

What is the significance of Schumpeter’s focus on barriers to entry in his analysis of competition?

Schumpeter’s focus on barriers to entry highlights that the most important factor in competition is not the number of firms, but whether new firms can enter and compete. Barriers to entry stifle innovation and limit competition, which can harm consumers and overall market dynamism.