Economics as a Social Science - Coursework Example

Economics as a Social Science By Due What is meant by ‘competition’ in the economy? Is it always desirable? Competition refers to a rivalry among sellers in a market where every seller attempts to outdo their competitors and maximize their profits, sales volume and market share. According to the classical view, competition is actually a very healthy practice. There is an “invisible hand” that makes competition work for the benefit of the market and makes it stable even though all the participants are driven by their own self interests. According to Smith (1776), “Every individual is continually exerting himself to find out the most advantageous employment for whatever capital he can command. It is his own advantage, indeed, and not that of the society which he has in view. But the study of his own advantage naturally, or rather necessarily, leads him to prefer that employment which is most advantageous to the society.” The participants have no intention to stabilise the market but their indulgence in competition achieves this end nevertheless. Further, the consumers are the biggest beneficiaries as they are able to get high quality products at very reasonable prices. Markets achieve equilibrium in a dynamic sense as it is a continued process in which excess profits and losses are automatically eliminated by the invisible hand. J.S. Mill (1848) did not give an accurate definition of competition but he argued that competition helps in determination of natural prices and incomes, and, importantly, it does so “independently of people’s will”. Classic economists generally believed that there are certain laws that regulate the economy and that they can be theorized. They have described competition as a very desirable endless equilibrating process among rivals. According to Smith (1776), firms are under constant pressure to bring innovation due to competition: “Competition of producers who, in order to undersell one another, have recourse to new divisions of labour, and new improvements of art, which might never otherwise have been thought of.” As prices get attracted to their normal levels, the profit rates, wages and rents also tend to stay at their normal levels. However, it is important to notice that it is assumed that the mobility of capitals is free; Adam Smith calls it “perfect liberty”. Classic economists have been unclear as to what are the requirements of competitive behaviour. Also, there are no clear explanations as to how the number of participants affects competition. However, there are some instances where classic economists seem to be supporting the neoclassical perspective of competition. For instance, Adam Smith (1776) says about monopolists, “Their competition might, perhaps, ruin some of themselves; but to take care of this, is the business of the parties concerned, and it may safely be trusted to their discretion. It can never hurt either the consumer or the producer; on the contrary, it must tend to make the retailers both sell cheaper and buy dearer...” If this quotation is analyzed, it can be seen that the primary competitive measures taken by rivals relate to lowering of prices and this is done regardless of the number of participants (Moudud, 2010). However, Stigler (1987) attached greater value to the number of participants in the light of the above quotation. Neoclassic economists believe that one of the earliest developments towards the theory of perfect competition lie in the aforementioned statement. However, classic economists never made any clear distinction between inter-industry and intra-industry competition. These two phenomena have distinct types of consumer behaviour which are discussed by classists in terms of different time spans (Salvadori, 2013). The model of perfect competition contains the analysis of competition in the neoclassical theory. There are certain assumptions for a perfectly competitive market to ensure that there is a perfectly competitive behaviour in the market. These assumptions are: There is a large number of small firms; There are no barriers to entry in the market for new firms; The product being sold is homogeneous; All the participants have perfect information about the prices and costs of the product; There is perfect mobility of factors of production; Neither the producers nor the consumers are capable of influencing the price of the product; every firm is a price taker (Satterthwaite & Shneyerov, 2007). Therefore, neoclassic economists believe that these assumptions must hold for static equilibrium to persist. Competition becomes more intense when the number of participants increases. The chances of establishment of a normal price rate increase with an increasing number of firms. This type of competition is desirable. However, where the number of participants is small, there is a great chance of creation of oligopolies and monopolies which would be discussed later. These are highly undesirable conditions as the consumers suffer. According to neoclassic economic theory, if a firm or the industry shows supernormal profits over a fairly long period of time, these profits are attributed to imperfections in the market operation. The concept of perfect competition first appeared in Cournot (1838), in which he related the number of firms to the market price. He also gave the concept of “unlimited competition” in which there are an infinite number of firms and the selling prices are equal to the marginal cost. The idea of perfect competition was also promoted by Edgeworth (1881) but he did not have much success. The dominance of classical views was a hurdle in the way of fame of this concept. Marshall attempted to assimilate the classical views with neoclassical ones. The first ever formulation of perfect competition into an operational model was achieved by Knight (1921) when he described ways in which the requirements of perfect competition could be used in the real economy. But this model was still very difficult to apply which is why the concept of monopolistic competition started to become widely accepted. Sraffa (1925) found out that the neoclassical view of perfect competition could hold true only where there is an assumption of constant returns to scale. Otherwise, a given price cannot coincide with the marginal cost hence making the size of the firm indeterminate and its supply decisions uncertain. Therefore, only partial equilibrium can be attained which can be seen in a monopolistic competition. Robinson (1933) clearly suggested that perfect competition should be marginalised as imperfect competition is more ubiquitous in reality. She says, “…it is more proper to set out the analysis of monopoly treating perfect competition as a special case.” It was later suggested by neoclassic theorists that perfect competition provides an ideal model of how competition should prevail in the market. Since imperfect competition is more generally observed in real life, the Government should intervene and remove these imperfections so that it can bring competition as close to the model of perfect competition as possible. One of the reasons of the Great Depression was that the imperfect competition was unchecked by the Government (dAspremont, 2011). It is due to imperfect competition that trade cycles have a very immense effect on economy. The following paragraphs discuss the imperfections that make competition undesirable in the economy. In a monopoly, the monopolist holds the power of regulating the price according to their own will. There are barriers to the entry of new firms. The most common barrier is created by the monopolist’s ability to produce the product at such a low cost that cannot be matched by any aspiring competitors. If there is a competitor, the monopolist lowers the price of their product so much that the competitor has no choice but bow out of competition. Some barriers are created legally as the Government may not allow any competition in the provision of certain services such as heat and power. But there is no exploitation in the services provided by the Government. Another drawback of monopoly is that there is inefficiency in the production of the product. The monopolists tend to produce at low levels. Their prices are higher than both marginal costs and average total cost hence resulting in allocative inefficiency. This does not happen in a perfect competition in which every producer’s price is equal to their marginal cost and there is no shortage in the market. But since the consumers have alternatives for the monopolist’s product, the monopolist does not try hard to serve their consumers well as it does not affect their business (Harrod, 1934). Another weapon in a monopolist’s arsenal is that of price discrimination. A monopolist segregates their market and identifies the subgroups for which the elasticity of demand is relatively inelastic. The monopolist then charges higher price on such subgroups. For instance, in airline travel, it can be seen that the travellers who have to travel within a short period of time are charged higher because their demand is relatively inelastic when compared to those who plan their travels in advance. Hence, under price discrimination, some consumers have to pay higher price than they would have if there were a single price. Small number of firms may also lead to the creation of oligopolies in which only a few firms dominate the whole market. These firms try to differentiate their product in order to make them look better than those of their competitors. These firms hold most of the share of the market and it is extremely difficult for the new entrants to match the prices of oligopolists. There is also a chance of allocative efficiency just like in a monopoly. But the biggest risk that oligopolies carry is that of creation of price cartels. Under these circumstances, firms in an oligopoly make an agreement to sell at a mutually agreed high price. Normally, none of the firms raises its price due to the risk of its loss of market share. But a price cartel provides them with a security that all the competitors would also raise their prices hence the market share for each firm would remain the same. Again, the consumers are the biggest losers as they are forced to pay higher than the price that would have paid in the absence of a cartel. Formation of cartels is held illegal in almost all the parts of the world and there are strict laws that restrict anti-competitive behaviour. In the US, anti-competitive behaviour can also result in a criminal charge. It can be seen from the above discussion that competition is actually a very good process that makes a market work efficiently. Classical economists deem competition as a highly desirable phenomenon but neoclassic economists suggested that perfect competition is an ideal model that is almost impossible to find in reality. Competition becomes undesirable when imperfections come into play and make the market inefficient. Further, some profit to the detriment of others. A closer look at imperfections suggests that competition actually becomes undesirable when it ceases to be a competition. It has been seen above that in a monopolistic competition, there is always a chance that a firm or firms would eventually be driven out of the market when they become too weak to compete. When there are no rivals, there is no competition. However, the terminology of monopolistic competition suggests that it is one of the forms of competition. If it is to be considered so, it is a very undesirable form of competition because it results in inefficient allocation of resources and exploitation of consumers. The imperfections must be removed so that competition can make the markets fair and efficient. It would also encourage the practices of research and development as the producers would strive to produce at a lower cost which is beneficial for the economy as a whole. Hence, competition, in its perfect sense, is a very desirable phenomenon. References Cournot, A. (1838). Researches into the Mathematical Principles of the Theory of Wealth. New York: AM Kelley, Publishers. dAspremont, C. (2011) Imperfect Competition and the Trade Cycle: Aborted Guidelines from the Late 1930s, History of Political Economy, 43(3): 513-536. Edgeworth, F. (1881). Mathematical Physics. London: Kegan Paul & Co. Harrod, RF. (1934) Doctrines of Imperfect Competition, The Quarterly Journal of Economics, 48 (3): 442-470. Mill, J.S. (1848 [1976]) Principles of Political Economy. Fairfield New Jersey: Augustus M. Kelley. Moudud, J. (2010) Strategic Competition, Dynamics, and the Role of the State: A New Perspective. New York: Edward Elgar. Knight, F. (1921). Risk Uncertainty and Profits. Boston: Houghton Mifflin. Robinson, J. (1933) The Economics of Imperfect Competition. London: MacMillan. Salvadori, N. (2013) The Classical Notion of Competition Revisited, History of Political Economy, Volume 45, Number 1: 149-175. Satterthwaite, M. & Shneyerov, A. (2007) Dynamic Matching, Two‐Sided Incomplete Information, and Participation Costs: Existence and Convergence to Perfect Competition, Econometrica, 75 (1): 155-200. Smith, A. (1776) The Wealth of Nations. New York: The Modern Library, 1976. Sraffa, P. (1925) Sulle Relazioni fra Costo e Quantita Prodotta, Annali di Economia, 2, 277-328 (English translation by Roncaglia, A. and J. Eatwell) Stigler, G. (1987) ‘Competition’, in J.Eatwell, M.Milgate and P.Newman (eds) The New Palgrave Dictionary of Economics, London. Read More