Final answer:
Adam Smith posited that competition fosters efficiency by keeping prices low and encouraging innovation. Real-world markets, however, may require policy intervention to maintain competition as firms grow.
Step-by-step explanation:
According to Adam Smith, competition fosters efficiency in the marketplace. In his seminal work 'The Wealth of Nations', Smith articulated the concept that open competition helps to keep prices low while encouraging businesses to improve their products and become more efficient. This efficiency stems from the necessity to outperform competitors, innovate, and attract consumers who have multiple choices.
The theory of the firm further explains that competition benefits consumers by providing lower prices and a variety of innovative products. However, in reality, markets are not always perfectly competitive, and as firms grow, often through mergers, there is a potential loss of competition. Policymakers must then decide on the level of intervention needed to maintain a balance between the advantages of large-scale production and the benefits of a competitive market.