Sunday, March 11, 2007

Understanding Economics: Competition

One of the essential features of a free-market economy is the existence of competition. The concept of competition necessarily goes together with the concept of choice.

The freedom to choose amongst whatever options exist for a given good or service is part of economic freedom. Competition means that everyone is equally free to produce some good or service.

When there is more than one producer, consumers can choose between more than one option. Sometimes different choices are preferred by different people, so people's desires are better satisfied by having more options. Other times, one product is clearly preferable to another for most consumers. In any case, more options mean equal or better satisfaction of customers' needs.

What incentives does competition create? Producers cannot depend on the business of those who seek the product they produce. If they wish to survive, they must continually strive to produce a product or service that many or all consumers find to be the best value. Thus the products available must continually improve. The improvement can be higher quality, more or better features, lower price, or some combination of the three.

This is exactly what has happened in real life. An amazing array of products have been created by businesses and entrepreneurs seeking profits. While they benefit by making profits, these profits are temporary, since someone else can always make a better product. But the consumers always win, since they keep getting better and better choices.

The opposite of competition is monopoly. This term is used to mean two very different things. One is simply that in a free market there happens to be only one provider of a given product or service. Others are equally free to enter the market if they so choose.

There is nothing terrible about this kind of monopoly. Any time some new product is invented, its inventor has a monopoly. Such monopolies do not usually last very long, as others will typically enter the market to seek the profits that are temporarily going to only one producer.

In rare cases, one company will be the only producer for some time. Even then, competition still exists because there is the potential for others to enter the market. This producer cannot afford to fail to serve the consumer, for then others will intervene and provide a better product.

Companies are often said to "control" a certain share of the market, when in reality whatever percentage of business comes their way is the result of free choices of consumers.

The other type of monopoly is a legal prohibition on competition. This type of monopoly can only be enforced by government through the threat of violence. Some businesses are all too happy to lobby government for restriction of their competition. Without the possibility of competition, they can charge higher prices and make larger profits over long periods. They don't need to innovate and serve their consumers to survive.

The US Postal Service is a legal monopoly, though it manages to be unprofitable due to unions and government subsidies.

Restrictions on competition are not usually quite so obvious. Government-enforced cartels restrict entry into a field with more than one producer. Private efforts to limit competition by having all producers charge the same price are certainly possible. But they usually fail since someone cheats. It takes government enforcement of such deals to make them effective.

Sometimes such schemes are sold as "stabilizing" prices, as if that's a good thing. Other times, they occur in the form of government "licencing". This is presented as protecting consumers, when often it simply restricts their choices. Government controls the licencing, so it can disallow certain competitors and allow other politically favored ones.

Producer competition and consumer choice are an essential part of the free market that greatly benefits society. They must be protected from government restrictions.


Anonymous said...

Allan, how do you feel about "monopoly companies," which you defined as a company that is the only one producing one product, when that company deliberately squashes and destroys and potential rivals? If some one starts a small business to compete with the large one, as you suggested, the large business drives the small one out of business, by aggressively targeting them, do you consider that morally sound?

After all, it makes good business sense for the company to eliminate it’s competition or even cut off potential competition before it exists. Then the large business then has a captive market who must buy their product or none at all. In this common situation the people are deprived of choice and therefore do NOT benefit when the company seeks to maximize it’s own profit. A company seeking to maximize it’s profits does NOT automatically benefit the people.

Matthew said...

There is a major difference between an apparent monopoly and an economic monopoly. The former is a business that appears to be a monopoly, but competition is still possible and thus the business can not afford to act economically as a monopoly. They must still produce and keep prices at a level as if they do have competition, because if they do not, the threat of competition is always there.

An economic monopoly is one that is not only the sole producer, but is free from even the threat of competition. Only without the threat of competition can monopolies employ monopoly pricing. These situations are extremely rare and usually only enforced by government.