Competition Theories - Essay Example

The primary role of government then is to ensure the flexibility of the market through supply-side policies. There were three main theories used to justify this - Free Market Theory, Say's Law, and the Quantity Theory of Money. In the Free Market Theory, it is assumed that if they economy were left to fend for itself, then it would tend to full employment equilibrium. For instance, in a classical scenario a surplus of labor equates into unemployment, which results in falling wages. Once wages fall, there would be an increased demand in labor, and hence equilibrium is achieved.

Say's Law (named after 19th century economist Jean Baptiste Say) argues that "supply creates its own demand", and gives credence to the traditional belief that the economy will make provisions for full employment. It states that an increase in supply will always have a resulting increase in demand, and since there will be no shortage in demand jobs will always be available. Unemployment would thus be temporary as the pattern of demand adjusts itself. Lastly, the traditional view of inflation is based on the Quantity Theory of Money.

Quite simply, this outlines that an increase in the money supply would lead to inflation. Thus, if the money supply could be controlled, inflation would be at a low. The Neoclassic approach to perfect competition essentially defines a competitive market as one in which there are a large number of small firms, all selling a homogenous good and possessing perfect knowledge. Using this analysis, it is the structure of the market which determines the inherent competitiveness of the market. The Austrian school of thought firmly rejects this.

Hunt (2000) states that the "Austrian school's theory of competition is noted for its insistence that competition is a process, and is not a thing, place, or collective entity." (p. 26) To the Austrian economist, competition is defined by rivalrous behavior, meaning competition is simply offering better deals than the prevailing competition. Competition arises from one firm establishing a pronounced differentiator that is parlayed into a sustainable competitive advantage against other firms.

Now, because firms in the real world do not have access to perfect information, the viability of a competitive strategy would not be known. Ergo, if one is to assume perfect knowledge, then in essence you are placing by the wayside the pressing quagmire that competition is supposed to solve. Consumer preferences are not handed on a silver platter, by taking part in the competition process firms discover them. Likewise, the cost-effectiveness of a firm's technology is never freely provided, this is something that is learned as well.

This makes the basic tenet of the Austrian theory of competition as "knowledge-discovery" - the challenge of working one's way through relatively incomplete information. In relative comparison, the Post- Keynesian theory of competition revolves around the premise of each plant being built on a scale lower than the optimum one. Soon after, the long-term average cost is prone to decrease and may lead to significantly increasing returns. Straffa (1926) put it succinctly in stating that "firms operating under perfect competition must be subject to decreasing returns of scale, and that increasing returns would only exist in the presence of a monopoly. (p. 535) The foundation of the Keynesian theory