Perfect Competition and Its Efficacy as a Policy Tool - Essay Example

Perfect competition and its efficacy as a policy tool Author Course Tutor Date Perfect competition and its efficacy as a policy tool Introduction The level of competition in a market is partly determined by how many suppliers are jostling for the demand of consumers. It may also be determined by how difficult it is for a new entrant to get into the market. It is typically more difficult for a new entrant to get into more competitive markets. The range of competition ranges from highly competitive markets where there are many sellers each of whom has a control of the market price to a purely monopolistic situation where the market is dominated by a single seller who has a great say regarding pricing of the product. This discretion exists in monopolies as long there is no regulation from the government. Perfect competition Perfect competition describes an idealized market structure that has an efficient allocation of resources. There is equality between profits and marginal costs, which is achieved through production of profit-maximizing quantities. The economic factors necessary for perfect competition are that all firms in the industry sell similar products; none of the firms in the industry should be big enough to determine prices. To prevent them from having the power to determine prices, all of the firms in the industry should have a small market share. Those buying from the industry should have full information on the nature of the product on offer. Players in the industry should be free to get in and go out (Kapeller & Pühringer 2010). Efficient allocation of resources is achieved when the society is satisfied to the extent that the production of more of one good and less of another would not increase the level of satisfaction. Equality between price and marginal costs results in efficiency because the price that generates buyers’ willingness to buy the product is often an indication of the satisfaction generated from production and consumption of the product (Koutsougeras 2009). Therefore, if a product proves to be more satisfying, customers are will pay a higher price for it. Marginal costs, on the other hand indicate the gain that has been given up when the decision to produce one good and not the other is made. If the product whose production has been foregone is in les demand than the one being produced, the marginal cost of production is low. When the foregone production increases satisfaction the marginal cost of production increases, efficiency is reached when the satisfaction gained from what is produced is equal to that which would have been achieved had the good foregone been produced (Khan 2010). Kapeller & Pühringer 2010 argue that perfect competition is good for producers and customers, this is because many sellers are most likely to sell at lower prices and purchase at higher prices from producers when there are many of them competing for merchandise and customers. It has been argued that these conditions do not exist at all in the real world. This is because no matter how similar products are, most of them have a certain level of differentiation. The closest there has been to the actualization of this theory is in the agricultural field where small scale farmers have no power to decide prices because none of them has a big enough market share. It is also relatively easy to get into small scale farming and also to get out, these two are, however the only attributes of perfect competitions noticeable and still a closer look at the markets shows that no product is produced solely by small scale farmers, there are always big producers who in many instances are able to determine prices. In instances where small scale producers are predominant, the buyer is only one making the market a monopsony. In order, for the conditions necessary for perfect competition to exist, in the general market, there has to be government regulation in the model of antitrust rules. In Hayek’s view, these regulations fundamentally alter the meaning of competition which should be characterized by rivalry. Imperfect competition Competition in the real world is different. In the neoclassical understanding of competition; it is categorized as imperfect competition. In this view competition is a mechanism which organizes self interests that are in conflict. It is characterized by sellers in the market, placing higher bids, selling at lower prices than competitors, offering better quality goods to consumers, offering better services etc (Ghemawat 2002). Vives 2008 describes it as a situation where sellers must outdo each other by offering high quality goods at a lower price while buyers compete by offering higher prices. Classical economists argued that self interests, which drive competition in an imperfect market do not result in lack of equilibrium, Adam Smith stated that even if all the players acted in self interest, competition is led by an invisible hand to promote an end which was no part of his (competitor’s) intention (Keen & Standish 2006). Mills (1848) argued that it is only through competition can the political economy can be considered a science. He further argued that as long as payments are determined through competition, they can be assigned laws. Mills and smith seem to conclude that any individual who pursues his own interests through competition also promotes the society’s welfare. This theory, however, does not give a clear description of the competitive behaviour required to attain equilibrium. Imperfect competition leads to oligopolies, monopolies, monopsonies and the like. Perfect competition and policy A study of development of the theory of competition shows that there are many schools of thought that could be used as benchmarks when developing a competition policy. However, the theory of perfect competition has, mostly been used as a benchmark. Considering the assumptions on which it is based, it is possible to advance an argument that the society’s wealth can be maximized under it (Keen & Standish 2006). The model, however, has major inconsistencies for analysis in the normative sense; it cannot be used to analyze market structures in the real world since such an analysis would mean comparing the real world to a perfect world (Ghemawat 2002). The model also assumes the nonexistence of either initiative on the part of the entrepreneur concerning certain competitive actions including advertising, product innovation etc. Since availability of all ideas necessary, for product improvement to all sellers at exactly the same time as insinuated by the theory of perfect competition would be impossible even if a powerful player like the government was involved; reaching the ideals required for perfect competition to be possible would require extreme measures on the part of the regulatory authority; this might mean prohibition of any form of product innovation (Dixit & Stiglitz 1977). Prohibition of innovation and the other extreme intervention measures that would be required would sound a death knell to any economy. According to Vives 2008 the main reason for the deficiency in perfect economy’s usefulness in modern economic analysis is that neoclassical theory, to which it is the benchmark model, has a narrow view of the nature and purpose of competition. In other situations in life, completion is intended to show has a greater aptitude in the matter for which a competition has been arranged. To determine who is best in an economic venture, it would be imperative to have them decide, for themselves, the issues that would give them an advantage over players gunning for the same clientele e.g. which goods are more needed in the market, how the goods should be priced or even whether what is currently in the market can be improved. The theory sees competition only through the lenses of the requirement for a certain social welfare standard while in reality; competition plays a much bigger role in the market economy. Another problem of the perfect competition model is the assumption that all players can have equal information regarding the product and the market. Having information is of vital importance in the information age, however not even in this age can there be a single individual with all information regarding an industry. It can however, be assumed that when one may lack information on a certain issue another player in the industry may have it while lacking the piece of information the other player has (Williamson 2000). Due to market failure the premise on which a workable competition policy is based is that the real market structure does not deliver the equilibrium envisaged by the perfect market model at all times. This reduces the usefulness of perfect competition in policy making. It is however important to note that the perfect model is used as a basis when governments make antitrust and laws and procedures to control monopolies. There are different schools of thought regarding the anti monopoly policy. The, so called, Chicago school holds that conduct determines performance, they argue that competition may result in different market structures some of which may lead to concentration while others may lead to the opposite scenario while both lead to an efficient performance in the industry. While perfect competition model would be violated by firms which gain a big market share, the Chicago school argues that firms that have gained a big market share should be commended for being innovative (Anderson et al 2001; Smith & Fred 1983). The perfect competition model has been used while making policies against price fixing there; however been arguments that collusion among firms in oligopolies to fix prices is not likely to happen since it would be counterproductive. Judging from the number of price fixing cases there has been around the world and the number of companies in the same industry that would attempt to fix prices, the conclusion that price fixing may not be particularly profitable in the long run (Nickell 1996). This conclusion further whittles down the efficacy of perfect competition as a policy making tool. Policy makers have other considerations that prevent perfect competition from offering a practical model on which policy could be based include: Encouraging innovation: As mentioned earlier, perfect competition does not encourage innovation on the contrary, it discourages innovation. When policy makers want to encourage innovation, they can definitely base policy on this model. Virtually all countries want firms established in them to prosper, the increased profits mean that the countries get more taxes and are also able to help these companies expand internationally. These are the considerations that inform many countries competition policies. The other consideration is Economies of scale. Industries experience economies of scale, it would therefore be a hindrance to productive efficiency if, to keep prices low, an array of practitioners are allowed into an industry in which firms survival is based on the size of their market share. Conclusion Considering the tight controls necessary to make operational a perfect market, and also the fact that players in such a market would not have the opportunity to showcase their abilities and use them for the betterment of their individual enterprises, it seems the only claim that perfect competition has to the name competition is the fact that more than one individual are involved in the ventures. This makes it difficult to disagree with Hayet’s conclusion regarding competition in perfect competition. Economic policy has to be based on economic realism this makes it necessary for policy decisions to be based on factual considerations. From the above discussion, perfect competition is not factual its inordinately high standard of what competition should look like is very likely to lead to erroneous policy decisions. This however does not mean that it is useless when it comes to issues of policy. As we have seen, it is useful as a benchmark in anti-trust and antimonopoly policy. These policies are of great importance and are needed to strike a balance between perfect competition which would kill innovation and cut throat competition which would deny the social imperative of economics. As a theory and a basis for argument and development of thought, perfect competition is definitely useful. Word count: 1984 Words. 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