Competition and Innovation in the Social Market Economy

But how did this actually come about? In movies from the 1990s, there are cell phones with an extendable antenna and the size of a brick. So, within 30 years, a process has taken place that has led to the development of mobile phones and smartphones as we know them today and use them every day.

This was made possible above all by the market mechanisms of the market economy. After all, innovations don't just fall from the sky. Rather, innovations in the market economy are the result of sometimes fierce competition between competing suppliers. On the following pages, you can find out exactly why this is the case, how competition and innovation are related to each other and why the preservation of competition is so important, especially in the social market economy.

Nowadays, almost every year a new smartphone comes out with new functions or features. And this despite the fact that the smartphone was only developed 20 years ago. Have you ever thought about why that is? Click through our presentation and find out what effects competition can have in a market economy.

The Different Economic Terms

Economy generally refers to all institutions and measures related to the production and consumption of goods. It cannot be considered in isolation. Economics is a branch of economics and studies relationships in the production and distribution of goods. It also deals with human action under economic conditions. In doing so, it searches for legalities and recommendations for policymakers.

"Economy" is generally understood to mean that the available resources are used as rationally as possible in a given area, because as a rule the resources are limited. If there were an infinite number of goods, we would not be forced to limit ourselves. The economy is therefore based on the assumption of scarcity of resources. In the case of commodities, such as crude oil, we know immediately that they are only available in limited quantities.

In recent decades, the principle of sustainability or the guiding principle of sustainable development has become increasingly important. For politics and business, this means that their actions must be geared in such a way that the natural foundations of life are preserved for future generations. Let's take a closer look at how "economics" works.

Why do consumers buy a product?

When you buy a product, you automatically participate in the market. In fact, as a consumer, you are even one of the decisive market participants on which other market participants, such as companies, orient themselves. Products that are preferred by consumers dictate to companies how they should align their future product range. This can affect both the features of a product, e.g. a smartphone with a powerful camera, and the price. Still too complicated? Maybe our little purchase scenario will help you. Have fun choosing a new smartphone. 

Gross domestic product (GDP)

GDP refers to the total value of the output generated within a fixed period of time (usually one year). It refers only to services within an economy and does not take into account intermediate consumption.

GDP measures the economic performance of an economy over a given period of time. With the help of GDP, changes can be detected. It is considered the central measure of an economy's economic growth.

The Federal Statistical Office is the leading provider of official statistical information in Germany. It regularly publishes up-to-date statistics.

Enterprise

Article 14 of the Basic Law guarantees citizens and businesses the right to property. This right creates a special incentive for individuals to provide services. This also applies to companies, as they want to be compensated for their risks and responsibilities. But what exactly distinguishes a company?

Characteristics of companies

Companies are often referred to by the terms companies, firms and businesses. They want to successfully market their products nationally and, if necessary, internationally. Companies are based on private property, self-determination of economic activity and the pursuit of profit.

Furthermore, companies can be classified according to the criteria

• the legal form (private or public law)
• the age/phase of the company (start-up, operating or dissolution phase)
• by industry (e.g. product performance or service),
• according to the size of the company, or
• also according to the spatial structure of the company's locations

distinguish

Companies pursue certain goals, which can be divided into the following categories:

• Economic goals: These are based on the long-term preservation of the company.
• Social and ethical objectives: These are determined by voluntary contributions from employers. Examples are, for example, payment practices, fair advertising or the humanisation of work.
• Ecological goals: These aim to avoid or reduce pollution of the environment. In many cases, you also rely on sustainable production.

Not all corporate goals are easily compatible with each other, i.e. conflicting goals can occur. A classic conflict of objectives is often seen between ecology and economy. Conflicting goals occur when, on the one hand, a goal (A) is achieved to a high degree, and on the other hand, goal (B) cannot be achieved or can only be achieved to a limited extent. For this reason, goals are divided into formal goals and objective goals. Formal goals are overarching goals that are important for the survival of the company. Objective objectives are subordinate objectives that serve to achieve the formal objectives.

The basic goals of a company are usually relatively abstract. They serve as a guideline for all future steps and can be seen as a framework for action. The company's policy is thus an ongoing process for the design and development of the company.

Companies, like households and the state, play a central role in the social market economy. All actors want to achieve their respective goals. The companies want to maintain their existence and successfully market their products. The state, on the other hand, pursues the goals of the social market economy. It sets the framework for entrepreneurial activity. The following diagram provides a conclusive summary of the objectives of state economic policy. The measured variables shown must be taken into account accordingly by the companies.

The task of markets is to coordinate economic processes. To do this, they coordinate the actions of countless companies and consumers. They can only fulfil this task if the companies are in competition with each other. Only then will prices be formed from supply and demand. Competition is therefore of great importance for a functioning social market economy and for basic social values. Therefore, the state safeguards the competition order through competition policy. But what exactly is behind this term?

Competition authorities

Cartels are prohibited because they fix prices or divide markets. Free competition is thus prevented. If companies merge (merger), they must report this to the state authorities once the companies reach a certain size. The German Cartel Office and the European Commission are responsible for this. Mergers can be prohibited by the two authorities if the newly formed company would gain too much market power. As market power increases, companies are exposed to less and less competition. The preventive control of mergers is intended to prevent this. In addition to prohibiting mergers, the authorities can also use the instrument of conditions: for example, companies can be obliged to sell parts of their company before a merger.

Features of the Contest

In addition to a "distributional function", competition also has a control function: competition forces suppliers to provide exactly the range of goods and services that consumers want. Most important, however, are the dynamic functions of the competition. It forces companies to adapt to changes in the markets as quickly as possible. The adjustment can relate to changes in demand or to falling or rising prices, e.g. for energy and raw materials. Companies that do not react or react too slowly will be penalized in competition by losing market share.

Protecting Functioning Competition – The Role of the State

Competition in the market economy therefore leads to a lot of positive outcomes, such as the further development of products or lower prices. Guaranteeing freedom of competition, i.e. the freedom of choice and action of suppliers and consumers, is therefore one of the cornerstones of the social market economy. While the actual market mechanism theoretically functions independently even without external control, the emergence and maintenance of free competition is not automatically ensured. You can find out why this is the case and what effects it can have in our presentation.

Characteristics of market forms

Thus, if the state or other institution does not monitor compliance with freedom of competition, there may be a concentration of market power. In fact, market forms exist depending on the country or specific industries. This means that sometimes there can be a single provider – or a large number of providers. There are markets with many customers as well as markets with only one customer. Depending on the nature of the market form, this may have different effects on the functioning of the market mechanism. Do you know which ones?

Policy for Functioning Competition as a Task of the State

In the social market economy, one of the tasks of the state is to guarantee freedom of competition. To this end, it pursues a competition policy. This policy can take very different forms and concerns several areas of responsibility. Click on one of the buttons and see what the tasks of the state are.