Perfect Competition Issues - Essay Example

Student’s Name: Institution of Learning: Instructor’s Name: Course Name: Perfect Competition The ideal of perfect competition is a theoretical concept that has been used as the core paradigm of economics from the start of the neoclassical period. According to the theory, the five standard features of a “perfectly competitive” market include a large number of small traders, minor barriers to market entry and exit, homogenous products, “perfect information,” and price-taking firms (see Arnold, 2001, p. 501 for a typical presentation of these characteristics). However, competition is undoubtedly imperfect in various markets such that, in many cases, the assumptions presented by the theory cannot be applied in reality. For instance, theoretically, perfect competition necessitates the assumption that individual buyers should not possess any market power (or prohibits monopsony power); however, this assumption can only be acceptable in a setting where there are infinite numbers of traders. In this regard, the practical usefulness of “perfect competition” is dependent on proving that it is an appropriate approximation for markets, where the number of traders is finite. However, it is not easy to simulate or create perfectly competitive markets with a finite number of agents. Such are the complexities inherent in the theory of perfect competition. In general, to understand any concept or theory, it helps to concretize what the concept or theory means or infers in reality. Through this method, an individual is able to see or prove whether the theory or suggested model is relevant according to the facts, or whether that theory or model is illogical and meaningless. Consequently, by concretizing “perfect competition” this paper attempts to show that the concluding relates to it. This critique of perfect competition is centred on criticisms offered in The Meaning of Competition extracted from the book Individualism and Economic Order by Friedrich A. Hayek. In addition, the paper will reflect of the types of competition that are likely to occur in a perfectly competitive market. Concretizing “perfect competition” Accordingly, to concretize the theory it is vital to consider the five assumptions or standards projected by the theory. The first assumption suggested in the model is product homogeneity so that there is no competition in terms of product differentiation in quality and style. This implies that for perfect competition to exist in the market, companies should not attempt to make their product dissimilar from or superior than their competitors’ products. As a result, this idea of “competition” essentially disregards one key characteristic of competition. Moreover, following this assumption, existing products would lack variety in such a market (the “perfect market”). Conversely, in the real marketplace; competition has the exact opposite effect, whereby, products must be differentiated to gain competitive edges over rival organizations. The second characteristic suggested by the theory is that industries should contain large numbers of small organizations so as to ensure that they are perfectly competitive. As such, this eliminates positive competition among firms to decline their costs, and acquire a competitive edge over their competitors through the realization of economies of scale. In retrospect, this is invariably, one of the most forceful features of competition in the real marketplace. Consequently, if all industries contained large numbers of small businesses, then production costs in various industries would be higher, this would result in declined productive ability and ultimately, lower standards of living. Again, this is the precise contradictory outcome that is accomplished by competition. The third idea is that an industry should have inconsequential barriers to entry and exit, for it to be perfectly competitive. This assumption overlooks a critical difference amongst the two categories of barriers to entry that individuals need to reflect on when evaluating whether competition exists. These types of barriers are mainly natural barriers and government levied barriers. Essentially, natural barriers, such as brand loyalty, high capital requirements, or goods production knowledge, are crucial components of real market competition and voluntary trade. For instance, a company achieves consumer loyalty or brand loyalty, by generating a unique product that consumers like so much that they cannot straightforwardly shift to a different brand. On the other hand, government enforced market barriers inhibit competition and voluntary trade and are accomplished by the introduction of physical force. These barriers are enforced by forcibly inhibiting some businesses from competing (such as by consenting government franchises), making market conditions more complex for some firms to compete in (using tariffs, licenses and quotas), or by offering a simulated advantage to some businesses (using subsidies). In essence, these categories of barriers constrain competition. Accordingly, by disregarding the main distinction amongst these categories of barriers to entry, the perfect competition ideal merges these fundamentally disparate concepts and assumes that, when any of these barriers are present, competition declines. In essence, this implies that the theory merges industries such as the taxicab industry (that has extensive government barriers) and the computer hardware engineering industry (that has high capital requirements) and states that competition is absent in these industries, due to the existences of these barriers. Conversely, this is true to a certain degree. Factually, the computer industry is exceedingly competitive due to the high capital requirements, and consequentially low overheads that have been attained in this industry. Indeed, realizing these low overheads is the direct function of the competitive process within that industry. On the other hand, competition is delimited in the taxicab industry due to the expensive government obligatory medallion which individuals must obtain, for them to be in the business legally. This government enforced barrier, consequently keeps numerous prospective competitors out of the industry. The fourth assumption is the idea that perfect information must be existent for a market to be categorized as perfectly competitive. This is obviously incongruous. According to the model, perfect information suggests that individuals must be all-knowing, so that competition exists in the market. Conversely, a measure of marketplace competition is competition regarding information and knowledge acquisition. Markedly, competition to acquire knowledge regarding the production approaches to use, competition to acquire knowledge regarding consumers, and competition amongst businesses to propagate information regarding them are all significant features of competition. Consequently, by supposing that individuals must possess flawless information in order to create a supposedly perfect form of competition, a key element of competition is vetoed. The fifth assumption according to the theory is that firms should be price takers in order to be recognized as being perfectly competitive. This assumption disregards the fact that a majority of companies fix their product prices with reference to the production costs they can realize. Accordingly, organizations compete strongly by constantly declining their costs, and fixing lower prices, so as to acquire a competitive edge over their competitors. Therefore, by necessitating businesses to be price takers, the model of perfect competition omits yet another key characteristic of competition. Indeed, perfect competition, as often acknowledged by leading economists, is not existent anywhere in reality. At times, it is suggested that agricultural industries are closer to being perfectly competitive since the products produced are almost being identical and the farmers accept whatever price they can contract for their products in the goods markets. However, even these industries do not satisfy the perfect competition standards in various ways. Firstly, it requires large amounts of capital to get into the agricultural business and secondly, perfect information does not, and cannot, be existent in farming or any other industry. Thirdly, significant barriers to enter the business exist in the form of the high capital and information requirements needed to enter this business. According to F. A. Hayek, perfect competition is not a type of competition at all; rather it actually denotes the nonexistence of all competition (Hayek). He argues that, under perfect competition model; competition is non-existent to differentiate individual’s products; there is no competition to achieve economies of scale and decline individual’s overheads, and there is no competition to acquire or propagate information. As such, the model of perfect competition is not a concrete concept since it does not speak to the actual character of competition and is not existent in reality (Hayek). Further, the use of the expressions “oligopoly” and “monopolistic competition” do not add relevance to the concept of perfect competition. Similarly, these terms are centred on the null and void models of economic monopoly and perfect competition and are used to categorize varying degrees of suspected monopoly power. Primarily, contemporary economists use monopolistic competition to define conditions where companies have slight variations in their products, and as a consequence, prompt violations of the key features of the perfect competition. In essence, the monopolistic competition concept states that monopoly power originates from slight differences amongst traders within the perfect market. This suggests that this concept is comprehensively ingrained in the notion that the “single -supplier” principles should be applied in establishing the existence of monopoly power. Characteristically, the concept simply recognizes firms that are not sole suppliers, but exhibit certain characteristics that are suggestive of them in sole supplier behaviours, in those firms. Pursuant to this, contemporary economists use the term Oligopoly to classify businesses that have finite companies within the industry, and those that have the greatest market share in that industry. This concept is founded largely on the amount and size of companies within industries and recognizes industries where the extent of supposed monopoly power is lies in between monopolistic competition and a “pure” economic monopoly. However, since the oligopoly concept is founded on the economic monopoly or perfect competition notion of competition and monopoly, it should also be rejected. Evidently, neither “oligopoly” nor “monopolistic competition” offers a superior understanding of the behaviour of competition and monopoly or the competitive nature of the businesses they classify since they are both founded on null and void opinions of competition and monopoly. According to Hayek, a better concept of competition is one established on rivalry. This concept states “to compete” an individual must attempt and exceed his or her competitors in manufacturing and voluntary trade. This means that a company should try to distinguish its product, decline its overheads and fix a lower price, advertise, and push its rivals out of the market, by influencing consumers to willingly switch to its product. Evidently, this offers a sound framework of how competition in reality occurs in any economic system (Hayek). As mentioned before, numerous economists have criticized the theory of perfect competition by proposing that the assumptions concomitant with the ideal do not parallel the actual features of real markets. These critics state that when the hypotheses are removed the model ceases to offer any valuable deductions about market behaviour. For instance, most critics agree that, in reality, the perfectly elastic demand curve does not exist since all businesses undergo a descendent sloping demand curve and hence have some "market power". In addition, the ideal of perfect competition has in many instances been used as the point of reference for anti-trust policy, whereby those involved in policymaking hold that it is the responsibility of the government to encourage perfect competition. I this way, policy makers often exploit the model by applying it as a normative standard in determining anti-trust actions to be adopted against businesses. How competitive is perfect competition Even though, perfect competition is a non-concrete and unreal market model, it is necessary to reflect on the forms competition that might occur within an economy that is perfectly competitive. In this regard, it is critical to note that price competition, occurring in the form of price wars or price-cutting by individual organizations, would not occur in a perfectly competitive market. Indeed, according to the fifth premise of perfect competition, all businesses are reflexive price-takers, capable to sell all the products they produce at the prevailing market price determined in the unabridged market. Accordingly, in such a situation, companies cannot increase sales or market share through price cutting. Further, other types of competition, encompassing the application of practices such as advertising, brand-imaging, packaging, or facility of after-sales service to set apart a business’s product from its competitors’ products merely rescind the standards of perfect competition. Accordingly, these are the types of competition which are predominant, alongside price competition, in the imperfectly competitive markets of the real economy. In view of this, the only form of competition that is appropriate to companies and that is also compatible with preserving the standards of perfect competition is cost-cutting competition. Cost-cutting competition is probable in perfect competition since every firm has the motivation to decrease costs or overheads, in order to gain supernormal profit. However, even the actuality of cost-cutting competition within the perfect market is questionable. For instance, it is necessary to establish why firms would fund research into progressive cost-cutting technicalities while other companies have prompt access to the entire market information. Moreover, it is necessary to establish why firms would invest in developing cost-cutting while they understand that any supernormal profits arising from effective cost-cutting are only temporary. Besides, from the perspective of a typical consumer in a perfectly competitive market, the choice is concurrently broad and narrow. Typically, the consumer has the indefinite superfluity of maximum choice with reference to the number of companies or traders from whom to buy a product. However, all the firms in this market offer identical goods or services at precisely the same price. Consequently, there exists no choice for the customer, in perfectly competitive market economy. Conclusion This paper has concretized the theory of perfect competition in order to offer a supporting argument to the article by F. A. Hayek. Indeed, the theory of perfect competition is too abstract to apply to the current market economy especially in the USA which is driven by large corporations in various industries. The assumptions prescribed by the model essentially disregard the nature and behaviour of competition in the real market. Furthermore, by examining the possible forms of competition that would occur in a perfectly competitive market, it is evident that this form of the market has no competition at all. This is the bottom line suggested by Hayek. Work Cited Hayek, Friedrich A. . "The Meaning of Competition." 15 March 2010. Mises Daily. 09 Dec 2012 . Read More