Perfect Competition : An Oxymoron?
The ‘competition’ aspect in perfect competition, as it is seen in mainstream economic theory, seems to hinge on the fact that there are so many producers of a homogenous product in the market that the market share captured by each individual producer is thus so miniscule that it exercises no control over the competitive variables (of either price or quantity) under consideration. In other words, perfect competition is at one extreme of the spectrum defined in terms of individual market power of firms (Kirzner, 2000). This is in accordance with the idea that a monopoly, lying on the other end, is the diametrically opposite case- all market power concentrated in the hands of a single firm. Categorising monopolistic, monopolistically competitive and oligopolistic market structures as ‘imperfectly’ competitive then sheds light on the implicit association of competition directly with the degree of dilution of market power. Pick up any one in a sea of modern textbooks on microeconomics and its chapter on Perfect Competition is as good a primer as any out there when it comes to delivering at its job of extolling the virtues of the model to serve as a benchmark (no matter how unrealistic and otherworldly) to compare other market structures to and to try and emulate as closely as possible wherever feasible, but this idea of perfect competition needs to be put to the test.
If one were to resort to extract the definition of competition in a market context from a layman, it would in all likelihood diverge from the one above in that it will entail luring in customers using any of the well-known strategies of slashing prices, innovating and improving the quality of the product and/or its production processes to differentiate one’s product from those of other producers, and advertising, to name a few. Indeed, this understanding is in accordance not only with that of the classicals, but also the Austrian School to which the views of Friedrich A. Hayek belong. As Israel M. Kirzner (2000) writes:
Following a long tradition in economics going back at least to Adam Smith, Austrians define a competitive market not as a situation where no participant or potential participant has the power to make any difference, but as a market where no potential participant faces nonmarket obstacles to entry. (para. 5)
That the debate surrounding the ‘meaning’ of competition is semantic in nature is not an unobvious deduction, although this in itself has caused a whole host of problems on its own, perhaps best portrayed by the existence of a paper by Oles Andriychuk (2011) discussing it which reads, “I presume that the concept of ‘perfect competition’ is often intuitively confused with that of ‘competitive process’. These are two independent concepts, but both are called ‘competition’, which causes an epistemic confusion and leads to important normative consequences” [Abstract]. To Kirzner (2000) however, “[…] together with, and underlying, the semantic squabble […], there is a profound substantive disagreement concerning the way in which markets work” (para. 7). This leads us to the most evident difference in the perception of competition in markets between the neoclassical and Austrian outlook, namely it being an emergent outcome by the former versus its embodiment in a process by the latter. It is this that Hayek (1948) conveys in his seminal The Meaning of Competition where he argues the case for a competitive process being a far more logically sound interpretation of competition rather than a market structure (pp. 92-106). It would not be very difficult to imagine that it is through the forms of competition (as understood colloquially) that producers would be able to come upon the knowledge that allows them to produce the given commodity while minimising the costs of production, just as it is through competition again that consumers are informed about the features and prices of products available for sale in the market. Implicit in the assumption of perfect knowledge among producers and consumers in the perfect competition model is the precursor to arrive at the implications of the model- the state of competitive equilibrium where room for competition has been all but exhausted. To employ an analogy from the natural sciences, this model provides as much of an insight into the competitive nature of markets as might one in physics used to demonstrate the 2nd law of thermodynamics by taking two bodies at the same temperature. By definition, there will be no flow of heat between the two since there is no difference in temperature.
Robert Frank (2007), for instance, illustrates the adoption of cost-saving innovations using the example of 18-wheel cargo truck drivers beginning to use air-foils all of a sudden in the mid-1970s as a way of reducing the impact of drag on trucks’ mileage (pp. 365-366). This may be seen as an exhibition of dynamism within the mainstream model, but since any such innovations are bound to be replicated by other firms and the ensuing economic profits are cursory, this greatly reduces the gains from and hence the ultimate incentive for R&D and entrepreneurial activity. Where this is not so is in what are known as ‘imperfectly’ competitive markets (where efficiency may not be optimised), but ironically it is their aberrations which one seeks to correct with the help of regulation (think all antitrust legislation and that concerning mergers, predatory price-cutting and so on), even though competition in its true sense continues to operate whether through R&D or by otherwise keeping producers on their toes as in the Contestable Market Theory. Staying loyal to our analogy, disavowing the competition in these markets is parallel to rejecting experiments that demonstrate the 2nd law of thermodynamics using bodies at different temperatures (between which heat flow takes place increasing the entropy of the system) only on the grounds of the inevitable dissipation of some amount of heat to the surroundings, a phenomenon which in itself obeys another law of thermodynamics, namely the impossibility of perfect efficiency in the transfer of energy from one body to another.
Since the neoclassical model only recognizes competition to operate on prices, (although consumption decisions depend on much more than just that) and there is no scope left for price-driven competition in the perfectly competitive model once all positive economic profit margins have been eroded, firms must simply accept the prevailing market price and mechanically produce their profit-maximising level of output reducing the market structure to what Demsetz (1997, p. 137) christens ‘imitative output competition’ more than anything else.
Perhaps now is the appropriate time to ask wherefore such a model that ostensibly seeks to describe competition in markets, but sorely misses the mark, actually arose in the first place, whether it really was envisioned into existence to describe the competitive ideal with the sole emphasis on price (and not other variables like quality)? Even so, the model commences with the price being taken, no doubt because the market works in mysterious ways; all the information already provided as to how exactly the commodity is to be produced most efficiently, perfect competition has impressively solved the much beloved, age-old economic problem of allocation of resources. Or was it envisaged rather to analyse how spontaneous order comes about in highly individualised markets centred around homogenous products particularly through a balance struck between aggregated opposing market forces in a manner that clears the market? If yes, then the famous Price = Marginal Cost relationship can also be inferred as a special case of the relations arising out of imperfectly competitive markets, for instance, the Lerner Index which denotes the amount of market power exercised by any form in terms of the proportion of the price that is a mark-up over the firm’s marginal cost [ (P- MC) ÷ P = 1 ÷ n |ε| ➜ 0 as n ➜ ∞ , ε being the market elasticity of demand and n the number of firms in the market).
Before satisfactory answers to these questions are found, it seems problematic to argue in favour of striving to attain the so-called ‘ideal’. Nor is continuing to cite social welfare as reason enough for its perpetuation justified, when in fact dynamic efficiency with constantly morphing tastes and preferences, besides the value assigned to variety and quality in goods and services, fails to feature in the model at all. Perhaps this distortion in the perception of competition itself arises from the restrictive formalistic conditions imposed as part of the model. Inasmuch as the classicals recognised the role of the entrepreneur in the face of uncertainty, they believed in the competitive process (Gordon, 1997, paras. 4-5,13). However, the transformations that the model has undergone since compel us to contend with our (over)reliance on deceptively simplifying models, “[…] not because such theorizing abstracts from some features of real-world markets, but because it abstracts from the very features of real-world markets that are most in need of being explained by any theory of competition” (Boudreaux, 2018, para. 34). To be apprised of this folly in the particular context at hand, one only has to look around and decide for oneself what fits the grandiose notion of ‘perfect competition’ and whether Voltaire (1772) was on to something when he wrote, “[L]e mieux est l’ennemi du bien” or “The perfect is the enemy of the good”.
Anoosheh Zahra Mirkhushal
SY B.Sc. Economics
References
Hayek, F. A. (2012). Individualism and Economic Order. University of Chicago Press.
Frank, R. H. (2007). Perfect Competition. In Microeconomics and Behavior. McGraw-Hill/Irwin.
Kirzner, I. M. (2000, March 01). The Irresistible Force of Market Competition. Foundation for Economic Education. https://fee.org/articles/the-irresistible-force-of-market-competition
Andriychuk, O. (2011). The Concept of Perfect Competition as the Law of Economics: Addressing the Homonymy Problem. Northern Ireland Legal Quarterly, 62(4), 523-538. https://pureportal.strath.ac.uk/en/publications/the-concept-of-perfect-competition-as-the-law-of-economics-addres
Boudreaux, D. J. (2019, October 29). The Theory of Perfect Competition Is Wholly Misleading. American Institute for Economic Research. https://www.aier.org/article/the-theory-of-perfect-competition-is-wholly-misleading/amp/
Boudreaux, D. (2018, January 20). A Case for Repealing All Antitrust Legislation. Cafe Hayek. https://cafehayek.com/2018/01/case-repealing-antitrust-legislation.html.
Gordon, D. (1997, October 01) “No Contest.” Review of Perfect Competition and the Transformation of Economics by Frank Machovec. The Mises Review 3, No.3, Fall 1997. https://mises.org/library/perfect-competition-and-transformation-economics-frank-machovec
White, L. H. (Host). (2016, July 18). Frank Machovec on Perfect Competition [Audio podcast episode]. In EJW Audio, Econ Journal Watch. https://econjwatch.org/podcast/frank-machovec-on-perfect-competition
Demsetz, H. (1997). Seventh Commentary: The intensity and dimensionality of competition. In The economics of the business firm: seven critical commentaries. essay, Cambridge Univ. Press.
Voltaire. (1772). LA BÉGUEULE, conte moral. In Contes en vers (Poésie tomes II et III) (p. 50).