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Why Perfect Competition Is not So Perfect

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Tags Monopoly and Competition

02/01/2018

According to the popular view, a proper competitive environment must emulate the perfect competition model.

In the world of perfect competition, a market is characterized by the following features:

  • There are many buyers and sellers on the market
  • Homogeneous products are traded
  • Buyers and sellers are perfectly informed
  • There are no obstacles or barriers to enter the market

Moreover, buyers and sellers have no control over the price of the product. They are price takers.

No Room for Entrepreneurs

The assumption of perfect information and perfect certainty implies that there is no room left for entrepreneurial activity. For in the world of certainty there are no risks and therefore no need for entrepreneurs.

However, if this is so, who then introduces new products and how? According to the proponents of the perfect competition model, any real situation in a market that deviates from this model is regarded as sub-optimal to consumers’ well-being.

It is recommended that the government intervene whenever such deviation occurs in order to again impose a competitive model closer to a state of perfect competition.

Also according to the popular view, the government must intervene to prevent the emergence of a situation where a producer dominates or monopolizes a market and sets the price above the truly competitive level. This, it is held undermines consumers’ well-being.

Not Even Potential Monopolists Can Charge Any Price They Want

In real life, though, the ability of a producer to monopolize a market is limited by several factors. 

First, we must note that the goal of the typical business is to make profits. This however, cannot be achieved without offering consumers a suitable price.

It is in the interest of every businessman to secure a price where the quantity that is produced could be sold at a profit. In setting this price the producer entrepreneur will have to consider how much money consumers are likely to spend on the product. He will have to consider the prices of various competitive products. He will also have to consider his production costs.

Any attempt on behalf of the alleged dominant producer to disregard these facts will cause him to suffer losses. Further to this, how can government officials establish whether the price of a product charged by a dominant producer is above the so-called competitive level?

How can they know what the competitive price is supposed to be? According to Murray Rothbard,

There is no way to define “monopoly price” because there is also no way of defining the “competitive price” to which the former must refer.1

If government officials attempt to enforce a lower price, this price could wipe out the incentive to produce the product. So rather than improving consumers’ wellbeing, government policies will make things much worse.

Variety in Products Is More Important than Variety in Producers

Contrary to the perfect competition model, what gives rise to a greater competitive environment is not a large number of participants in a particular market but rather a large variety of competitive products. The greater the variety is, the greater the competition will be and therefore more benefit for the consumer.

Government policies, in the spirit of the perfect competition model, are however, destroying product differentiation and therefore competition.

The whole idea that various suppliers should compete to offer a single homogeneous product or service is not tenable. For if this were the case why would a buyer prefer one seller to the other? The whole idea to enforce product homogeneity in order to emulate the perfect competition model will lead to no competition at all.

Since product differentiation is what free market competition is all about, every supplier of a product has 100 percent monopoly control as far as their specific product is concerned. After all, in an unhampered market, no two products are exactly alike, and each supplier is therefore, in a way, a monopolist.

What gives rise to the product differentiation is that every entrepreneur has different ideas and talents. This difference in ideas and talents is manifested in the way the product is packaged, the place it is sold, the way it is offered to the consumer, etc.

For instance, a hamburger that is sold in a beautiful restaurant is a different product from a hamburger sold in a take away-shop. So if the owner of a restaurant gains dominance in the sales of hamburgers should he then be restrained for this?

Should he then alter his mode of operation and convert his restaurant into a take away-shop in order to comply with the perfect competition model? All that has happened here is that consumers have expressed a greater preference to dine in the restaurant rather than buying from the take-away shop. So what is wrong with this?

Let us now assume that consumers have completely abandoned take-away shops and buying hamburgers only from the restaurant, does this mean that the government must step in and intervene?

We suggest that the whole issue of a harmful monopoly has no relevance in a free marketplace.

A harmful monopolist can only emerge when the government, by means of licenses, restricts the number of suppliers in a particular industry.

By imposing restrictions and thus limiting the variety of goods and services offered to consumers, it is government that curtails consumers’ choices, thereby lowering their well-being.

  • 1. Murray N. Rothbard, Man Economy and State (Auburn, Ala.: Mises Institute), pp. 606–07.

Frank Shostak's consulting firm, Applied Austrian School Economics, provides in-depth assessments of financial markets and global economies. Contact: email.

Note: The views expressed on Mises.org are not necessarily those of the Mises Institute.
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