Volume 43, Number 170,
July-September 2012
Economic Competition in Mexico:
A Much Needed Debate
Rogelio Huerta
COMPETITION THEORY AND THE PROFIT MARGIN

In any microeconomic textbook, the classification of markets is normally presented in the following way: perfect or pure competition, pure monopoly, monopolistic competition, oligopolistic or duopoly markets. To identify each of these markets, it is relevant to know the number of existing companies in the market, as it is self inherent, according to these textbooks, that the greater the number of companies that compete in the market, the more intense the competition. Thus, in the monopoly and the duopoly, markets with one or two or few competitors (if oligopoly), competition does not exist or is extremely low. On the contrary, in the perfect competition and monopolistic competition markets, there are a lot of competitors, and competition is intense. The difference between these last two types of markets is the degree of product homogeneity. In perfect competition, the good or service is completely homogeneous and it is assumed that competition is not due to differences among products. This phenomenon, product differentiation, is crucial for monopolistic competition.

From Estrada’s point of view, “competition grows when there are more rivals” (2010;126). So, a monopolistic market (a single producer) will have no competition, but it will increase as more independent companies come into existence. In this sense, the degree of production concentration is an indicator of the intensity of competition. It is an inverse relationship: the greater the degree of concentration, the lower the level of competition and vice versa, the lower the degree of concentration, the greater the intensity of competition. For this theory to hold up, we must assume that the product (good or service) being exchanged in the market is totally homogenous. That is, that there is no difference among the products due to the company and as such, competition is centered on prices and does not affect product differentiation.

This microeconomic textbook theory is what makes Estrada conclude that greater competition will drive prices down and that monopoly will impede price reduction. Why? Because according to this vision, companies subject to greater competition will seek to assign their resources more efficiently, which will reduce costs and allow prices to drop. The contrary situation exists with a monopoly. When the producer does not have competition, he is indifferent to producing with elevated costs, because he can assign a high price for his goods. In summary, orthodox microeconomic textbook theory links competition to efficiency, and monopolies to inefficiency.

To support his statements, Estrada cites various studies. A study from Høj et al. (2007) analyzes information from many other research documents prepared by the ocde and concludes that, “regulations that restrict competition increase operations margins, especially in non-manufacturing industries” (2010:126). Estrada declares that the authors he cites faced difficulties in measuring the concept of competition, and due to these difficulties, they chose to use operations margins of companies as an approximate variable. He maintains that the profit or operations margin has been used to measure competition intensity and that policies to foster or increase competition are positively correlated with low profit margins, while regulations that impede competition raise these margins. Specifically, he states that profit margins are lower in the manufacturing sector because the goods they produce are exposed to international competition, in contrast with the majority of services whose profit margins tends to be higher, because they are difficult to commercialize internationally. Thus, international competition causes profit margins to fall.

This conclusion is based on the idea that competition among many, and in particular free competition, is better, as it implies a tendency towards price reduction, and as a consequence, profit margin reduction. From the other direction, competition and policies to foster competition reduce profit margins, which in turn drives prices down. All of this assumes a competitive framework or a perfect competition market, where prices are flexible and fall in response to cost reductions. However, it is worth it to slow down a little bit and explain the difference between price and cost in a theoretical framework where prices are not flexible, but rather somewhat rigid, or better said, a competitive market with fixed prices.

Why does the price-cost difference vary? In other words, why does the profit margin vary? What is proposed here is that the profit margin can fall for various reasons, besides price reduction, especially when taking into account a market where the product is not homogeneous.

The profit margin may fall if, considering the constant costs of production, the company invests in sales efforts to increase their competitiveness. These sales efforts consist of publicity expenses and other expenses to set their products apart. Both types of expenses intensify competition and may also bring about a reduction in the profit margin as a secondary effect, as commercialization expenses increase due to greater costs for sales efforts. However, it is advantageous for the company to invest in these sales efforts, because as sales increase due to these efforts, and prices remain constant, total profits may increase if the elasticity of sales over sales efforts expenses is greater than one.

In other words, lower profit margins may result from an intensification of competition due to higher innovative expenses to set the product apart, and not due to a greater number of competitors or price reduction, as the authors suggest in the essay that Estrada cites to support his idea that greater competition is reflected in lower prices, and as a consequence, in lower profit margins. Even lower profit margins, when a result of increase in publicity and promotion expenses to set the product apart, mean that competition intensifies through non-conventional means, based on an ideal model of perfect competition and price reduction with homogeneous prices.

Published in Mexico, 2012-2017 © D.R. Universidad Nacional Autónoma de México (UNAM).
PROBLEMAS DEL DESARROLLO. REVISTA LATINOAMERICANA DE ECONOMÍA, Volume 49, Number 192, January-March is a quarterly publication by the Universidad Nacional Autónoma de México, Ciudad Universitaria, Coyoacán, CP 04510, México, D.F. by Instituto de Investigaciones Económicas, Circuito Mario de la Cueva, Ciudad Universitaria, Coyoacán,
CP 04510, México, D.F. Tel (52 55) 56 23 01 05 and (52 55) 56 24 23 39, fax (52 55) 56 23 00 97, www.probdes.iiec.unam.mx, revprode@unam.mx. Journal Editor: Alicia Girón González. Reservation of rights to exclusive use of the title: 04-2012-070613560300-203, ISSN: pending. Person responsible for the latest update of this issue: Minerva García, Circuito Maestro Mario de la Cueva s/n, Ciudad Universitaria, Coyoacán, CP 04510, México D.F., latest update: Feb 23th, 2018.
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