Abstract for: Competition Between Firms – System Dynamics and Other Approaches

The role of system dynamics in modelling economic systems has been under- appreciated. As well as the balancing feedback of the market mechanism, the occurrence of bubbles is widely seen as a reinforcing feedback phenomenon, but it is less widely understood that the tendency to exponential growth in successful modern economies is likely to represent a distinct type of reinforcing feedback. This paper presents a system dynamics model of an arms race between competing firms based on cost competition, which displays the property of reinforcing feedback: a price fall by one firm encourages the other to invest so as to reduce its unit costs and thence its price. The other firm then responds in kind. Under these circumstances, the unit cost and price of both firms show a steady decline that mimics the historic decline in real input required to make a given product, e.g. as measured by the number of labour hours. This depends on both firms being able to reduce its unit cost, but is robust to other changes. The ability to produce the same output with reduced real inputs is equivalent to generating a larger output from the same resources, and is one source of economic growth.