Friday, August 21, 2009

"Perfect" Competition

Economists and pundits like to defend certain government interventions--such as the regulation of utilities and the provision of roads--on the grounds that "perfect" competition cannot exist for certain services. The argument is similar to that used to defend "natural" monopolies--in the absence of government intervention, the "public interest" cannot be served.

According to Wikipedia, "perfect" competition consists of:
  • Many buyers/Many Sellers – Many consumers with the willingness and ability to buy the product at a certain price, many producers with the willingness and ability to supply the product at a certain price.
  • Low-Entry/Exit Barriers – It is relatively easy to enter or exit as a business in a perfectly competitive market.
  • Perfect Information - Prices are assumed to be known to all consumers and producers.
  • Transactions are Costless - Buyers and sellers incur no costs in making an exchange.
  • Firms Aim to Maximize Profits - Firms aim to sell where marginal costs meet marginal revenue, where they generate the most profit.
  • Homogeneous Products – The characteristics of any given market good or service do not vary across suppliers.
When these conditions do not exist, it is often argued that government must intervene to protect consumers. But even a cursory review of this criteria would reveal that no product or service does, or can, meet this standard. For example, virtually no two products are exactly the same (except perhaps for items like paper clips and thumb tacks). Or, professional athletics certainly have high entry barriers, yet they are very competitive.

The truth is, the demand for "perfect" competition is an example of the fallacy of rewriting reality:
Unable to determine what they can or cannot change, some men attempt to “rewrite reality,” i.e., to alter the nature of the metaphysically given. Some dream of a universe in which man experiences nothing but happiness—no pain, no frustration, no illness—and wonder why they lose the desire to improve their life on earth. Some feel that they would be brave, honest, ambitious in a world where everyone automatically shared these virtues—but not in the world as it is. Some dread the thought of eventual death—and never undertake the task of living.
Those who clamor for "perfect" competition dream of a world that is much different from what actually exists. They demand omniscience on the part of consumers and producers (perfect information). They demand an absence of standards (low entry barriers). They demand many sellers, which automatically eliminates innovation and new products (homogeneous products). And when they do not find the world of their dreams, they demand that the government create that world. Their demands and dreams however, will not alter reality--not individually and not collectively.

The desire for "perfect" competition is the desire for a Garden of Eden, a panacea in which individuals do not need to exert effort or thought. It is a fantasy. And the attempts to make it real will ultimately result in a nightmare.


Eric said...

You have a knack for posting on topics just as I encounter them in discussions with my liberal friends and relatives. This post and your series on natural monopolies have both been extremely timely. You've helped me articulate free market principles to others and better understand them myself.

Please keep up the excellent work!

Brian Phillips said...

Thanks Eric. I can assure you that I am not psychic and my posts are a coincidence.

I do try to address issues that I see in the news or elsewhere, so that may be the explanation. Natural monopolies for example, had recently come up in a comment.

Harold said...

Don't really have a specific comment, but I enjoyed the article. Thanks.