Opinion Editorial | |
| Wednesday, June 16, 1999 | |
The Flawed Idea of "Perfect Competition" |
Anyone who has ever taken an economics course probably has heard the term "perfect competition" at one time or another. Perfect competition, the professor likely said, is an essential prerequisite for capitalism. As my college economics textbook (Samuelson, 7th ed.) put it, "The virtues claimed for free enterprise are fully realized only when the complete checks and balances of 'perfect competition' are present."
The problem is that the conditions necessary for the achievement of perfect competition are extremely high. In his book, "Risk, Uncertainty, and Profit," the great economist Frank Knight listed 11 different conditions that had to be met before perfect competition was established. Among them: no buyer or seller is large enough to affect prices by themselves, there must be no barriers of entry into any market, all participants have perfect knowledge, and there must be no transactions costs, among other things.
Clearly, it would be impossible to satisfy all these conditions. Therefore, critics of capitalism have always been able to justify government regulation and other interventions into the market on the grounds that perfect competition does not exist. Economists, on the other hand, have been handicapped in opposing government intervention because they have accepted the perfect competition standard.
Over the years, a few economists have tried to argue that perfect competition is unnecessary and irrelevant. Indeed, in a sense, the primary motivation in the economy is a desire to achieve some degree of monopoly. That is why firms spend so much money on research and development, and why they are constantly striving to innovate and find new products, processes and marketing tools. If they are successful and manage to beat the competition, they will, for a time, be the only game in town. That allows them to charge quasi-monopoly prices until such time as their competitors figure out how to copy and improve upon their accomplishments.
The important thing to remember is that under these circumstances any sort of monopoly power is fleeting. No sooner does a fashion designer come up with a new style than knock-offs are available at the nearest K-Mart. The same is true in every other area of the economy. New software designs spawn imitators, GM copies Ford's latest best-seller, and the newest miracle ingredient in shampoo immediately appears in all the others. Trademarks, copyrights and patents can put up barriers to copycats, but in the long run a company can only stay on top through continuous innovation that constantly keeps its competitors off balance.
But even if one still accepts that perfect competition is some sort of ideal to strive for, changes in our economy brought about by computers and the internet are in fact bringing us closer to it. The internet now makes it possible to have something pretty close to perfect knowledge about products. One can almost instantly compare prices, product quality and availability everywhere at once. And continuously improving delivery services mean that distance is less of a barrier all the time. The same is true for thousands of other products as well, including industrial materials.
The spread of auction sites is a further step toward true perfect competition. Consumers can offer their own prices for airline tickets, hotel rooms and a growing number of other goods and services every day. Businesses can buy tons of hot-rolled steel, tankers of lubricants and train cars full of cylinders, if they like, at the lowest price available anywhere at that moment.
In conclusion, although the idea of perfect competition is flawed, it turns out that we are getting closer to it all the time anyway.
Source: Bruce Bartlett, senior fellow, National Center for Policy Analysis, June 16, 1999.
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