Theory of dynamic competition

Standard economics teaches of “perfect competition” as an equilibrium outcome where price equals marginal cost, economic profit is zero and efficiency is maximised. This is a static theory of competition. Competition is also a process and the theory of that process is the “theory of dynamic competition”.

This essay suggests that dynamic competition drives economic growth. Further, efforts aimed at achieving static competition (eg restricting mergers and market behvaiour) are likely to harm dynamic competition and therefore harm economic growth.

What is “dynamic competition”?

Dynamic competition is the process by which market players attempt to maximise their profits by competing in a marketplace that has other players who are also trying to maximise their own profits and welfare. 

Dynamic competition cannot be measured by the number of firms in a market or by how close the market is to “perfect competition”. Dynamic competition is measured by the barriers to entry and exit.

Dynamic competition is a constant process of innovation and immitation as firms attempt to organise their resources in such a way to maximise profits (by increasing revenue and/or decreasing costs). For an individual business, innovation and immitation are both new knowledge with costs to acquire.

The drive to acquire knew knowledge comes not only from the desire for more profit, but also from the more urgent desire to not lose current profits (or go out of business). Monopoly-pull incentive v competition-push incentive.

As knowledge requirements are constantly changing (changed preferences, resources, competitor behaviour etc) a firm must constantly be searching for new knowledge.

While immitation and innovation have the same impact on an individual business (as they are both new knowledge to the individual business) only innovation increases the total store of knowledge in an economy. Consequently, only innovation drives economic growth.