Competition

Perfect competition

The theory of competitive prices

Alternative concepts

Empirical evidence of competition

Public policies

BIBLIOGRAPHY

OTHER WORKS CITED

Competition may be the spice of life, but in economics it has been more nearly the main dish. Competition has been a major force in the organization of production and the determination of prices and incomes: economic theory has accorded commensurate importance to the concept.

Competition enters all major areas of man’s life and generally connotes rivalry between two or more men or groups for a given prize. Competition is often an end in itself. Sporting events are clear illustrations: we should be shocked if two teams called off the event or arranged a tie and divided the prize. Indeed, the prize is a minor goal in a true sporting event.

In economic life competition is not a goal: it is a means of organizing economic activity to achieve a goal. The economic role of competition is to discipline the various participants in economic life to provide their goods and services skillfully and cheaply.

Perfect competition

Market competition

When one asks (as Cournot was the first to do in a precise way in 1838) whether the competition of three merchants will serve better than two, or why two (or three) do not combine into a monopoly, the answers prove to be elusive. But one can partially evade such questions by posing a very extreme degree of competition, which the economist calls perfect competition.

A main requirement of perfect competition is that the largest firm in an industry make a trifling fraction of the industry’s sales (or purchases) and therefore that there be many firms in the industry. No definite number has been found for the maximum share of one firm that is compatible with competition; presumably the permissible share can be larger the more elastic the industry demand and the easier the conditions of entry by new firms.

These many firms, no one or few of which account for an appreciable share of the industry’s output, are assumed to act independently. This can be viewed as a second condition for perfect competition, or as an inevitable corollary of the large numbers in the absence of legal controls over the industry. For it is a fact that there are insuperable difficulties in organizing an effective combination of many persons when it is profitable for each person secretly to depart from the agreement, as is generally the case in economic life.

Such large numbers suggest what is true: that (perfect) economic competition is impersonal. In the economic race there are 1,000 or 100,000 runners, and each gets a prize proportional to his efforts. The fortunes of any one firm are independent of what happens to any other firm: one farmer is not benefited if his neighbor’s crop is destroyed. The essence of perfect competition, therefore, is not strong rivalry but rather the utter dispersion of power to influence market behavior. The power, for example, to restrict quantities sold and raise prices is effectively annihilated when it is divided among a thousand men, just as a gallon of water is effectively annihilated if it is spread over a thousand acres.

A third condition of perfect competition is complete knowledge of offers to buy and sell by the participants in the market. This condition serves just the opposite purpose of the preceding condition. The assumption that traders act independently serves to keep them apart and, hence, numerous; the assumption that each seller knows what various buyers will pay, and vice versa, is necessary to keep the parties together—in the same market. If seller S and buyer B dealt only with one another in ignorance of all other traders, and similarly for every other pair of buyers and sellers, each transaction would represent an exchange under bilateral monopoly.

These conditions of perfect competition are enough to ensure that a single price will rule in a market (in fact, perfect knowledge is enough for this purpose) and that this price is affected only negligibly by the actions of any one or few buyers or sellers. (It is sometimes additionally assumed that the product of all sellers be homogeneous, but this can also be viewed as part of the definition of the market or industry.) The definition of perfect competition is therefore sometimes expressed in the equivalent form: the demand curve facing each seller is infinitely elastic; and the supply curve facing each buyer is infinitely elastic. (This definition also applies to the individual firm, which accordingly may be competitive even though the market in which it trades is not competitive.)

To these basic conditions of perfect competition—numerous traders on each side of the market, independence of action, and perfect knowledge—it is necessary to add divisibility of the commodity or service being traded. If the units are large, it is possible that minor discontinuities will emerge that allow some small market power to individuals. The point is sufficiently minor to be left to references (Edgeworth [1881] 1953, p. 46; Stigler 1957, pp. 8–9).

These conditions of perfect competition pertain to a single market, whether of shoes or bonds or carpenter’s services. So far as the presence or absence of monopoly power is concerned, it is not necessary to look at any other market. For this reason these conditions pertain to what may be called market competition.

It is traditional, however, to enlarge the conditions of competition, so they will ensure an optimal allocation of resources, by specifying the nature of the movement of resources among markets and industries. This enlarged concept, which may be termed industrial competition, is our next subject.

Industrial competition

If a productive resource is to be utilized efficiently, it must be equally productive in all of its uses—clearly if its (marginal) product is less in one use than another, output is not being maximized. Hence, two additional conditions commonly have been made a part of perfect competition: resources are mobile among uses; and their owners are informed as to yields in these various uses.

A vast galaxy of private and public barriers to the mobility of resources has been erected in various times and places: boycotts, certificates of convenience and necessity, patent licenses, settlements laws, franchises, licensing of occupations. Such barriers are all actually or potentially incompatible with competition. But it is not necessary for competition that the movement of resources be free: the retraining of a worker, or the transportation of a tool, may be costly without interfering with competition. We must enlarge our earlier condition of full information to include knowledge of the yields on resources in alternative employments. From another viewpoint, we may say that ignorance is a barrier to profitable movement of resources.

If these conditions are fulfilled, the maximum possible output (measured by value) will be obtained from a productive resource. If this be true for each resource, the output of the economy is at a maximum. This famous theorem (labeled “on maximum satisfaction” by Walras and Marshall) is subject to a qualification, as all interesting propositions are: the private marginal product of a productive resource (the amount its owner receives and hence what governs its allocation) must equal the social marginal product (private marginal product plus or minus the effects on others). Of course, the maximum value output is dependent upon the distribution of income, which affects the demands for goods and hence their prices.

Time and competition. What we have termed industrial competition—competition including mobility of resources—obviously has an implicit time dimension. It takes time to move resources out of unprofitable fields, especially if the resources are specialized and durable, so that only through disentangling depreciation funds can the resources be withdrawn. It takes time, too, to construct a new factory or shop when one wishes to enter an industry. Comparable statements can be made about the geographical and occupational mobility of labor. Similarly, time is a factor in the completeness of knowledge. It takes time to learn which industries or jobs are most remunerative, or to learn the prices quoted by various sellers, or the quality of service and product; and one’s knowledge is more complete and reliable, the more thorough the search for information and the larger the experience on which it is based.

Capital embodied in specialized and durable equipment will not be transferred to other uses in the short run except at extreme price differentials, even though in the long run the slightest differential in returns may be sufficient to move capital funds. Conversely, only under extreme incentives will new establishments be created virtually overnight, as we sometimes observe in wartime.

This fact that it is more expensive to do things very quickly than at a slower pace does not qualify the proposition that resources will tend to be put where they earn the most, but we are reminded of the implicit proviso: allowance must be made for the cost of moving the resources.

The differences in returns to a resource in various uses can be very great in the short run, but will decline in the long run to a minimum level set by the cost of the most efficient method of moving resources. There is implicit in economic literature the belief that these minimum costs of movement of resources are very small relative to their returns, so little imprecision arises from neglecting them entirely. This may be true but has not been demonstrated. The belief, nevertheless, led economists (for example, J. B. Clark) to postulate instantaneous and costless mobility as the pure case of perfect industrial competition. It seems preferable to say that minimum differentials in returns to resources are achieved only in the long run. Market competition is not so intimately related to time. One’s information about price bids and offers improves somewhat as one searches the market more thoroughly—itself a time-consuming process—but the changing conditions of supply and demand lead to changes in prices that make the old information obsolete.

The theory of competitive prices

The competitive structure of industry leads to the establishment of competitive prices. Competitive prices are characterized by two main properties. The property of clearing markets is that of distributing existing supplies efficiently; the property of equalizing returns to resources is that of directing production efficiently.

The clearing of markets

A competitive price is one that is not perceptibly influenced by any one buyer or seller. When we say that such prices are fixed by “supply and demand” we mean that the ensemble of all buyers and sellers determines price.

Since every buyer can purchase all he wishes of the good or service at the market price, there are no queues or unsatisfied demands, given the price. Since every seller can sell all he wishes at this market price, there are no undisposable stocks, other than inventories that are voluntarily held for future periods. The competitive price, then, clears the market—it equates the quantities offered by sellers and sought by buyers.

Whenever we find a persistent queue among buyers, we know that the price is being held below the level that clears the market, which we naturally call the equilibrium price. For example, when housing is unavailable under rent controls, we know that rents are below the equilibrium level. Whenever we find stocks held by sellers to be in excess of inventory needs, we know price is above the equilibrium level. The vast stocks of agricultural products held by the U.S. government are evidence that the prices of these products (more precisely, the amounts the government will lend on the products) are above the equilibrium level.

The importance of prices that clear markets is that they put goods and services in the hands of the people who most urgently wish them. If a price is held too low, some buyers who set a lower value on the commodity will get it while others in the queue who set a higher value get none. If the price is set too high, goods that buyers would be glad to purchase at a lower price go unsold even though (if a minimum price is imposed on a competitive industry) sellers would prefer to sell at this lower price.

The equalization of returns

It is part of the definition of industrial competition that every resource in an industry earn as much as it would earn in other industries, but no more. The self-interest of the owners of productive resources (including, of course, that most important resource, the laborer) leads them to apply their resources where they yield the most and thus to enter unusually attractive fields and abandon unattractive fields.

This equalization of returns, however, can be shown to imply that the prices of goods and services equal their (marginal) costs of production. The cost of a productive service to an industry is the amount that must be paid to attract it away from other uses—its foregone alternatives. (This most basic concept of cost is the essence of the alternative or opportunity cost theory.) If the amount the productive resource earns in an industry is in excess of this cost, clearly other units of the resource presently outside the industry could earn more if they entered. Conversely, if the productive resource is earning less than its cost or alternative product, it will leave the industry. Hence, if price exceeds cost, resources will flow into the industry and lower the price (and perhaps raise cost by raising the prices of the resources); if price is less than cost, resources will flow out and increase the price (and perhaps reduce cost).

The equality of the marginal products of a resource in all its uses is the condition for efficient production. The equality of average products has often been substituted, with a regrettable loss of logic: consider the catastrophic waste (of capital) in having equal output per worker in two industries when the capital equipment per worker is ten times as large in one industry as in the other. But if the marginal product of a resource is equal in its various uses, it follows that marginal cost must equal price. The resources necessary to produce one more unit of product A could produce an equal value of B, so the marginal cost of A—which is the foregone alternative of producing B—is equal to the value of A that it produces. Marginal cost, formally defined as an increment of cost divided by the increment of product associated with the increment of cost, and not the more easily measured average cost (total cost divided by output), is the economist’s fundamental criterion of competitive price—and of optimum price.

Marshall’s period analysis

The alternative uses open to a resource depend upon the time available for its redeployment (or more fundamentally, how much one is willing to spend on its movement). This principle, joined to an empirical observation that one can alter the rate of operation of a plant much sooner than one can build a new plant or wear out an existing one, provides the basis for the standard (Marshallian) theory of long-run and short-run competitive prices (Marshall 1890).

In the short run, defined as the period within which one cannot appreciably alter the number of plants (physical production units), the only method of varying output is to work a given plant more or less intensively. The so-called variable productive factors (labor, materials, fuel) are the only resources with effective alternative uses in this period and therefore the only services whose returns enter into marginal costs. The returns to the productive factors embodied in the plant are called quasi rents. So long as quasi rents are greater than zero it will be more profitable to operate a plant than to close it down.

The long run is defined as the period within which the entrepreneur can make any desired decision—including the decision to leave one industry and enter another. In this period all resources are variable in quantity, and therefore the returns to all factors enter into marginal cost.

The Marshallian apparatus permits very useful simplifications in price theory, but only if its underlying empirical assumption is fulfilled: the long-run adjustments of the firm are of negligible magnitude in the short run (and hence can be neglected), and the short-run adjustments do not appreciably affect the long-run costs. When these conditions are not met (they fail, for example, if discharge of workers in this period will lead to higher wage rates in the next period), the full analysis of the short run will still require explicit analysis of the long-run repercussions of the short-run decisions.

Alternative concepts

The austerity and abstractness of the concept of perfect competition have led many economists to seek a more “realistic” concept. This search has been reinforced by the need for a concept of competition usable in the enforcement of the U.S. antitrust statutes. A variety of concepts have accordingly been proposed, but because they were deliberately contrived to fit the infinitely varied circumstances of a vast economy they lack the analytical clarity of perfect competition.

Workable competition

The most popular of these variant concepts is that of J. M. Clark, which he labeled workable competition (1940). The philosophy of this concept is clear enough: actual industries will seldom have thousands of independent firms, and never will the entrepreneurs have complete knowledge. It is not useful to characterize all of these industries as imperfectly competitive, for some will be near-monopolies and others will have prices, outputs, and rates of progress that deviate in only minor respects from what perfectly competitive industries would experience. In particular, many industries do not depart sufficiently from perfect competition (which is, of course, unattainable) to create any need for antitrust actions or public regulation.

Workable competition has been a very popular concept since its formalization in 1940, but its serious ambiguity has not yet been reduced. How competitive an industry should be (using observable criteria we shall discuss below) to be workably competitive has never been settled. Indeed the criteria (prices, service, product innovation, rates of return) that deserve most weight in any application of the concept have not been agreed upon. Two competent persons who study a particular industry can disagree on its workable competitiveness, and there exists no analytical basis for eliminating the disagreement.

Monopolistic competition

The other leading concept, monopolistic competition, was formulated by E. H. Chamberlin (1933) and is directed to a different purpose. Chamberlin emphasized the diversity in the products of firms that are normally considered members of a single industry: they differ in details of quality, in repute, in locational convenience, in the religion of their producer, and a hundred other details that may influence their desirability to various buyers. He emphasized also the substitutability of products made by what are viewed as different industries: one may use aluminum or steel or wood to build a chair, and ostentatiously display one’s wealth with jewels, servants, or trips abroad. Each firm, in this view, has some elements of uniqueness (monopoly power) and yet many rivals, and the admixture gives rise to the title of the concept. The theory of monopolistic competition has led to a much more thorough examination of the problems of defining commodities and industries. It has not been found useful in the analysis of concrete economic problems.

Competitive equilibrium

The lack of conscious coordination of the behavior of individuals in a competitive market has led many writers to assert the impossibility of any stable equilibrium. Some have denied that any order is observable: the Continental cartel literature usually uses the word “chaotic” as a prefix to competition, and most proposals for an “orderly” policy assume that a competitive system is disorderly. Others have found cumulative tendencies in competition: for example, W. T. Thornton said that “if a single employer succeed in screwing down wages … his fellow-employers may have no alternative but to follow suit” ([1869] 1870, p. 105). Sidney and Beatrice Webb elaborated this view into their famous theory of “higgling in the market” ([1897] 1920, part 3, chapter 2).

Modern economic analysis, on the other hand, makes competitive equilibrium the central part of the theory of prices and allocation of resources. The presence of order and continuity in markets composed of many independently acting buyers and sellers has been established beyond serious question, on both theoretical and empirical grounds.

The main stumbling block in the layman’s acceptance of competitive equilibrium is the belief that many individuals acting independently will necessarily either undershoot or overshoot every appropriate change in output, prices, investment, and the like. If, for example, increasing demand calls for a 10 per cent increase in industry capacity, how can this precise total be achieved when a vast number of firms are individually and independently changing their plants in a hundred different proportions? In a sense this is a false question: no one can know that the following year’s demand will be exactly 10 per cent larger, and neither a public body nor a private monopolist can guarantee to have the “right” amount of capacity the next year. But let us put this complication aside.

The answer, then, is that there is much information available to guide the decisions of the numerous independent firms. In part this is current information: every trade is abreast of the investment decisions of its various firms, of the developments in products and production methods, and so on. This information comes from salesmen, trade journals, customers and suppliers, and a host of other sources. The firm is guided also by past behavior in the industry: if previous increases of output were supplied in some part by new firms, this becomes a factor in current decisions.

Empirical evidence of competition

A variety of statistical tests of the existence of competition have been proposed at various times, and at least three deserve some attention.

The presence of numerous firms, none dominant in size, is directly observable and is usually described by a low concentration ratio. The main difficulty with this structural test of competition is that the maximum concentration compatible with competition has not been determined, so the test is clear only when concentration is low. The problem is complicated by the fact that we have had no theoretical guide in summarizing the frequency distribution of firm sizes, which can, of course, be done in many ways.

Since a single price will rule under perfect competition, price homogeneity has often been proposed as a test of competition. We have already remarked that perfect knowledge is enough to ensure a single price, whether the market is competitive or monopolistic. Indeed, in a market of numerous sellers and buyers it is improbable that all prices in a given short interval of time will be uniform. It is improbable for two reinforcing reasons: the transactions will seldom be in completely homogeneous goods (quantity discounts, promptness of payment, and a dozen other characteristics vary almost infinitely among transactions); and the cost of learning market prices, given numerous traders, is such that complete information is not worth it. As a result, strict uniformity of prices has properly been viewed by the courts as a phenomenon more suggestive of collusion than of competition.

A related evidence of competition is more powerful: the absence of systematic price discrimination. If sellers are persistently obtaining higher net receipts (which need not be the same as prices) from some buyers than from others, we may be confident that they are acting in concert—a truly independent firm would concentrate its sales on the buyers who yielded higher net receipts.

A fourth, and perhaps the most traditional, test of the absence of competition is a high rate of return on investment. It has lost much popularity because of the difficulty of measuring profitability (in particular, the valuation of durable assets can conceal monopoly profits or create fictitiously high rates of return) and because an absence of high profits is compatible with various cartel arrangements. Yet it is true that unusually high or low rates of return will not persist for long periods in a competitive industry. More specifically, a recent study suggests that in unconcentrated manufacturing industries the rates of return of one year will provide no useful clue to the rates earned, say, five years hence (Stigler 1963, chapter 3).

Public policies

Laws, both statutory and common, have sought to protect competition for centuries. The Statute of Monopolies, which was passed in 1623 to restrain the crown’s use of grants of monopoly for revenue, was a famous example, as were the statutes (which Adam Smith compared in rationality to laws against witchcraft) against forestalling, engrossing, and regrating grain.

The Sherman Act of 1890 was pathbreaking, therefore, not in its prohibition of restraints of trade but in the implementation of this policy by an administrative force charged with ferreting out and prosecuting such acts. This most basic of all antimonopoly laws forbade not only conspiracies in restraint of trade but also attempts to monopolize—and in such broad terms as almost to defy conflicts of spirit and letter. Criminal penalties were supplemented by the incentive of triple damages to private parties who were injured by the forbidden acts.

The complaint that the Sherman Act came into force only after competitive markets had been destroyed (which was neither true nor wholly false), the belief that a group of specialists could deal with industrial problems more effectively than the judiciary, and the general impatience of reformers— all combined to bring about in 1914 the Clayton Act, which prohibited a set of practices that (it was believed) often led to monopoly, and the act creating the Federal Trade Commission to enforce the Clayton Act. With amendments—the most important being the Robinson-Patman Act of 1936 and the Celler-Kefauver Merger Act of 1950—the legislative basis of U.S. policy had been developed. This policy includes certain discordant anticompetitive elements (the Robinson-Patm an Act, with its goal of rigid uniformity of prices, and the legalization of resale price maintenance), as general policies have a habit of doing.

That this policy has contributed to the competitiveness of the U.S. economy is difficult to deny or to document. Yet international comparisons—in particular, of the same industry (often composed of the same firms) in Canada and the United States —suggest that the policy has had substantial effects. So, too, does the fact that the favorite practices of the formal cartel—a joint sales agency or division of customers—are quite uncommon in the United States.

The policy of restricting agreements among competitors (but not the policy of seeking to prevent monopolies) has spread to numerous other nations since its introduction in the United States. The most common form is to require registration of agreements among firms in an industry, and the subsequent approval or disapproval of the agreement by a specially constituted body. This is the practice of England, Germany, and several other nations, as well as of the European Common Market.

George J. Stigler

[See alsoAntitrust legislation; Cartels and trade associations; Industrial concentration; Markets and industries; Mergers; Monopoly; Oligopoly.]

BIBLIOGRAPHY

Chamberlin, Edward H. (1933) 1956 The Theory of Monopolistic Competition: A Re-orientation of the Theory of Value. 7th ed. Harvard Economic Studies, Vol. 38. Cambridge, Mass.: Harvard Univ. Press.

Clark, John M. 1940 Toward a Concept of Workable Competition. American Economic Review 30:241–256.

Edgeworth, Francis Y. (1881) 1953 Mathematical Psychics: An Essay on the Application of Mathematics to the Moral Sciences. New York: Kelley.

Knight, Frank H. (1921) 1933 Risk, Uncertainty and Profit. London School of Economics and Political Science Series of Reprints of Scarce Tracts in Economic and Political Science, No. 16. London School of Economics; New York: Kelley.

Marshall, Alfred (1890) 1920 Principles of Economics. 8th ed. New York: Macmillan.

Stigler, George J. 1957 Perfect Competition, Historically Contemplated. Journal of Political Economy 65: 1–17.

Stigler, George J. 1963 Capital and Rates of Return in Manufacturing Industries. A study of the National Bureau of Economic Research. Princeton Univ. Press.

OTHER WORKS CITED

Thornton, William Thomas (1869) 1870 On Labour: Its Wrongful Claims and Rightful Dues. 2d ed., rev. London: Macmillan.

Webb, Sidney; and Webb, Beatrice (1897) 1920 Industrial Democracy. New ed. 2 vols. in one. London and New York: Longmans.

Competition

BIBLIOGRAPHY

In neoclassical economic theory, the highest state of competition is called perfect competition in which there are a large number of small-sized firms each of which is assumed to be a passive price taker. With perfect information flows and mobility, inter-industrial competition ensures equalized profit rates across all sectors. Finally, intra-industrial competition ensures identical technologies thereby leading to equalized profit rates between firms within each industry. At equilibrium there is full capacity utilization.

Various models of imperfect competition, in which firms are price setters, are seen as the opposite of perfect competition. Under monopolistic competition there are a large number of firms. With free entry and exit, each firm’s downward-sloping demand curve intersects the average total cost to the left of its minimum point on its average total cost curve. At the resultant equilibrium, there is excess capacity with higher-than-minimum cost and price.

Under oligopolistic competition, game theory is used to model strategically competitive behavior among a relatively small number of firms whose market power allows them to erect barriers to entry. Game theory, in which each firm is assumed to have the information to be able to anticipate precisely the actions of rival firms, generates a payoff matrix and devises the most optimal competitive strategy. At equilibrium, each firm maintains excess capacity to deter competition (Dockner et al. 2000, p. 253). As discussed below, this situation is likely to be unsustainable under Keynesian uncertainty when each firm strives to cut costs and prices.

The problem with all the above models is that none includes price- and cost-cutting behavior, an odd failing given the reality of outsourcing to low-wage regions of the world. The remaining part of this essay deals with three different theoretical schools that have rejected the neoclassical theory of competition. We first deal with the classical Marxian perspective (Clifton 1983; Shaikh 1980, 1982; Semmler 1984; Botwinick 1993). The central argument in this literature is that the quantity and size of firms is immaterial with regard to pricing: all firms are aggressive price setters. The pursuit of surplus value leads to increased levels of mechanization. Thus a larger scale of investment forces firms to increase their market shares in order to make such large investments profitable. Price-and cost-cutting constitute the main methods by which each firm “makes room for itself” in the market. Furthermore, this literature rejects the notion that large-sized firms have market power and therefore erect barriers to entry, since in recessions such firms can face barriers to exit. The presence of large amounts of sunk costs makes it difficult for such firms to disinvest, thereby making them subject to potentially heavy losses.

Indeed, it is the presence of varying levels of fixed capital that makes capital mobility across industries a relatively slow process. Quite simply, it takes time to invest and disinvest. Thus profit rates are likely to be different from one another at any given moment. Profit rate equalization happens only as an approximate process over what Karl Marx (1818–1883) called “the cycle of lean and fat years” (Marx 1894, p. 208).

Finally, technological change and fixed capital imply the existence within an industry of different technology vintages, each with its own unit production costs. With roughly equal selling prices, this implies the coexistence of different profit rates. The issue of monopoly power is irrelevant to both intraindustrial and interindustrial competition.

Based on the prewar survey work done by the Oxford Economists’ Research Group (Andrews 1949), Roy Forbes Harrod (1900–1978) radically revised the conventional model of imperfect competition. As in the classical Marxian perspective, price- and cost-cutting are at the core of Harrod’s critique (1952).

Harrod’s critique begins with the standard assumptions of monopolistic competition: price-setting behavior, free entry and exit, and a downward-sloping demand curve faced by each firm. Harrod argues that the standard equilibrium in which there is excess capacity with aboveminimum costs and prices is not sustainable since each firm faces a penalty for not minimizing costs and prices. The threat from potential low-cost rivals in a world of Keynesian uncertainty makes every firm defensively lower its costs and prices in an attempt to safeguard its market share. In the event of excess capacity, each firm will cut back investment, thereby reducing its capacity. In the aggregate, the reduction of investment will also reduce aggregate demand and thus output. With overutilization of capacity, the increase in investment will raise both aggregate capacity and output (demand). In either case, a solution to the knife-edge problem (Shaikh 1989) will ensure that output and capacity are approximately equal to each other around the minimum point of each firm’s cost curve.

Finally, the Austrian school contends that static equilibrium and perfect information preclude the real-world rivalrous competitive behavior that entrepreneurs engage in under capitalism (Kirzner 1997). Austrian authors emphasize the fact that competition actually takes place under conditions of fundamental uncertainty that are not subject to probabilistic calculations. This in turn implies that price and quantity setting by firms may propel the system away from equilibrium for considerable periods, although there could also be tendencies toward equilibration. Competition is, in effect, a dynamic process.

SEE ALSO Competition, Managed; Competition, Perfect

BIBLIOGRAPHY

Andrews, P. W. S. 1949. Manufacturing Business. London: Macmillan.

Botwinick, Howard. 1993. Persistent Inequalities: Wage Disparity Under Capitalist Competition. Princeton, NJ: Princeton University Press.

Clifton, James. 1983. Administered Pricing in the Context of Capitalist Development. Contributions to Political Economy 2: 23–38.

Dockner, Engelbert J., Steffen Jorgensen, Ngo Van Long, and Gerhard Sorger. 2000. Differential Games in Economics and Management Science. Cambridge, U.K.: Cambridge University Press.

Harrod, Roy Forbes. 1952. Economic Essays. New York: Harcourt.

Kirzner, Israel. 1997. Entrepreneurial Discovery and the Competitive Process: An Austrian Approach. Journal of Economic Literature 35 (1): 60–85.

Marx, Karl. [1894] 1967. Capital. Vol. 3. Reprint, New York: International.

Semmler, Willi. 1984. Competition, Monopoly, and Differential Profit Rates: On the Relevance of the Classical and Marxian Theories of Production Prices for Modern Industrial and Corporate Pricing. New York: Columbia University Press.

Shaikh, Anwar M. 1980. Marxian Competition versus Perfect Competition: Further Comments on the So–Called Choice of Technique. Cambridge Journal of Economics 4: 75–83.

Shaikh, Anwar M. 1982. Neo–Ricardian Economics: A Wealth of Algebra, a Poverty of Theory. Review of Radical Political Economics 14 (2): 67–83.

Shaikh Anwar M. 1989. Accumulation, Finance, and Effective Demand in Marx, Keynes, and Kalecki. In Financial Dynamics and Business Cycles: New Perspectives, ed. Willi Semmler, 63–86. Armonk, NY: Sharpe.

Jamee K. Moudud

COMPETITION

Competition is the battle between businesses to win consumer acceptance and loyalty. The free-enterprise system ensures that businesses make decisions about what to produce, how to produce it, and what price to charge for the product or service. Competition is a basic premise of the free-enterprise system because it is believed that having more than one business competing for the same consumers will cause the products and/or services to be provided at a better quality and a lower cost than if there were no competitors. In other words, competition should provide the consumers with the best value for their hard-earned dollar.

ASPECTS OF COMPETITION

To be successful in today's very competitive business world, it is important for businesses to be aware of what their competitors are doing and to find a way to compete by matching or improving on the competitors' product or service. For example, if Pepsi-Cola offers a new caffeine-free soda, Coca-Cola may offer a new caffeine-free soda with only one calorie. By offering an improvement on the competitor's product, Coca-Cola is trying to convince soft-drink consumers to buy the new Coke product because it is an improvement on Pepsi's product.

While being aware of the competition and making a countermove is important, it is also very important to pay attention to changing consumer wants, needs, and values and to make the needed changes before the competition does. Doing research and development and being the first to provide a new product or service can give a company a competitive advantage in the marketplace. Once consumers purchase a product or service and are satisfied with it, they will typically purchase the same product again. Having a competitive advantage means that a company does something better than the competition. Having a competitive advantage might mean inventing a new product; providing the best quality, the lowest prices, or the best customer service; or having cutting-edge technology.

To determine an area where a company might have a competitive advantage, a SWOT analysis is often done to identify the company's internal S trengths and W eaknesses and the external O pportunities and T hreats. A SWOT analysis lets the company know in which area(s) it has a competitive advantage so it can concentrate on those areas in the production and marketing of its product(s) or service(s).

In addition to staying on top of changing consumer preferences, companies must constantly be looking for ways to cut costs and increase productivity. Companies must provide consumers with the best-quality product at the lowest cost while still making a profit if they are to be successful competitors in the long run. One way to remain competitive is through the use of technology. Technology can help speed up production processes through the use of robots or production lines, move information more accurately and more quickly through the use of computer systems, and assist in research and development proceedings.

Global competition has made gaining consumer acceptance an even tougher challenge for most businesses. Firms in other countries may be able to produce products and provide services at a lower cost than American businesses. In order to compete, American businesses must find other ways to win consumers. One way for businesses to accomplish this is through competitive differentiation. Competitive differentiation occurs when a firm somehow differentiates its product or service from that of competitors. Competitive differentiation may be an actual difference, such as a longer warranty or a lower price, but often the difference is only perceived. Difference in perception is usually accomplished through advertising, the purpose of which is to convince consumers that one company's product is different from another company's product. Common ways to differentiate a product or service include advertising a better-quality product, better service, better taste, or just a better image. Competitive differentiation is used extensively in the monopolistic form of competition, discussed below.

FORMS OF COMPETITION

Although each form has many aspects, not all of which can be considered here, competition can generally be classified into four main categories: perfect competition, monopolistic competition, oligopoly, and monopoly. (Table 1 summarizes the basic differences among these four types of competition.)

Perfect Competition

Perfect competition (also known as pure competition exists when a large number of sellers produce products or services that seem to be identical. These types of businesses are typically run on a small scale, and participants have no control over the selling price of their product because no one seller is large enough to dictate the price of the product. Instead, the price of the product is set by the market. There are many competitors in a perfect competition industry, and it is fairly easy to enter or leave the industry. While there are no ideal examples of perfect competition, agricultural products are considered to be the closest example in today's economy. The corn grown by one farmer is virtually identical to the corn grown by another farmer, and the current market controls the price the farmers receive for their crops. Perfect competition follows the law of supply and demand. If the price of a product is high, consumers will demand less of the product while the suppliers will want to supply more. If the price of a product is low, the consumers will demand more of the product, but the suppliers will be unwilling to sell much at such a low price. The equilibrium point is where the supply and the demand meet and determine the market price. For example, if the going market price for wheat is $5 a bushel and a farmer tries to sell wheat for $6 a bushel, no one will buy because they can get it for $5 a bushel from someone else. On the other hand, if a farmer offers to sell wheat for $4 a bushel, the crop will sell, but the farmer has lost money because the crop is worth $5 a bushel on the open market.

Monopolistic Competition

Monopolistic competition exists when a large number of sellers produce a product or service that is perceived by consumers as being different from that of a competitor but is actually quite similar. This perception of difference is the result of product differentiation, which is the key to success in a monopolistic industry. Products can be differentiated based on price, quality, image, or some other feature, depending on the product. For example, there are many different brands of bath soap on the market today. Each brand of soap is similar because it is designed to get the user clean; however, each soap product tries to differentiate itself from the competition to attract consumers. One soap might claim that it leaves you with soft skin, while another soap might claim that it has a clean, fresh scent. Each participant in this market structure has some control over pricing, which means it can alter the selling price as long as consumers are still willing to buy its product at the new price. If one product costs twice as much as similar products on the market, chances are most consumers will avoid buying the more expensive product and buy the competitors' products instead. There can be few or many competitors (typically many) in a monopolistic industry, and it is somewhat difficult to enter or leave such an industry. Monopolistic products are typically found in retailing businesses. Some examples of monopolistic products and/or services are shampoo products, extermination services, oil changes, toothpaste, and fast-food restaurants.

Oligopoly

An oligopoly exists when there are few sellers in a certain industry. This occurs because a large investment is required to enter the industry, which makes it difficult to enter or leave. The businesses involved in an oligopoly type of industry are typically very large because they have the financial ability to make the needed investment. The type of products sold in an oligopoly can be similar or different, and each seller has some control over price. Examples of oligopolies include the automobile, airplane, and steel industries.

Monopoly

A monopoly exists when a single seller controls the supply of a good or service and prevents other businesses from entering the field. Being the only provider of a certain good or service gives the seller considerable control over price. Monopolies are prohibited by law in the United States; however, government-regulated monopolies do exist in some business areas because of the huge up-front investment that must be made in order to provide some types of services. Examples of monopolies in the United States are public utility companies that provide services and/or products such as gas, water, and/or electricity.

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Marcy Satterwhite

COMPETITION

The concept of competition is well known in the fields of economics. In everyday usage, it also connotes a kind of positive, creative energy that fuels our markets. As mainstream use of the Internet grew exponentially through the 1990s, so did competition among the industry's many players. Hordes of upstart companies that became known as dot-coms emerged. They competed aggressively with one another, and with traditional industry leaders, to gain dominance in market niches such as online discount travel services and online product evaluation services. Competition was particularly intense in the online services sector between America Online (AOL) and rivals like Compuserve and Prodigy, and in the personal computer (PC) industry as players like Dell Computer Corp. used the Internet to challenge the dominance of larger competitors.

AOL made one of its first competitive moves in the early 1990s. Launching an intense branding program, which included giving AOL software away for free, the company also began growing its content via alliances with news firms like Tribune Co., Knight-Ridder, and CNN. By the mid-1990s, rivals CompuServe and Prodigy had begun to eat into AOL's market share. To boost subscriber rates, AOL forged an important agreement with Microsoft Corp. in 1996. As a result, AOL agreed to include Microsoft's Internet Explorer browser in its software, and Microsoft agreed to include AOL software on its Windows 95 platform. AOL sought similar alliances with AT&T Corp., Apple Computers, Sun Microsystems, Hewlett-Packard Co., and Netscape Communications. The firm also continued to hone its services to make them as easy to use as possible. According to AOL CEO Steven Case, as quoted in the October 1996 issue of Forbes, "If you want to reach a mainstream audience, you have to make it more plug and play. One-stop shopping. One disk to install. One price to pay. One customer service number to call." AOL set its competition back even further in September of 1997 when it purchased the consumer online service of CompuServe Corp. The acquisition boosted AOL's subscriber base to more than 10 million, placing major rivals such as Microsoft Network, AT&T WorldNet, and Prodigy at a distant second place.

Like AOL, Dell Computer Corp. also proved successful in its efforts to outperform competitors. When the firm was founded in April of 1984, it used a direct sales model rather than going through traditional retail outlets. As a result, Dell's machines were less expensive than those of other PC vendors, such as IBM Corp. and Compaq Computer Corp. In addition, the firm began offering on-site setup, maintenance, and repair services for its products in 1987. When Japanese PC firms began lowering their prices, Dell hired a former IBM Corp. executive to oversee the firm's efforts to manufacture machines higher in quality than those of their Asian rivals. Along with focusing on improved technology, the firm also continued to develop its customer service practices. All employees were required to attend a six-week training program to learn how to answer questions, resolve complaints, take orders, and help clients select the best options for their computing needs. Weekly staff meetings included discussions about how to best resolve customer complaints. Dell's efforts, along with its leading ranking on J.D. Powers & Associates' first customer satisfaction survey regarding PC makers, moved the firm from 22nd place to sixth place among the largest U.S. PC manufacturers.

Dell was unique among PC makers in the early 1990s because it actually gained from the economic recession of the time, as those shopping for PCs began to seek less expensive options. However, at the same time the firm found itself facing competition from up-start direct sales vendors, such as Gateway 2000, which eventually usurped Dell as the top U.S. direct seller of PCs. One of Dell's most important moves in its quest for PC market share was to begin selling its PCs and related equipment on the Internet in 1996. Customers were able to place their orders on Dell's Web site as easily as they had done via the telephone. In 1997, roughly one-third of the orders Dell received were being placed on the Internet. More importantly, the majority of these online customers were new to Dell.

When PC prices began falling in the late 1990s, Dell found its Internet savvy even more important. As stated in a BusinessWeek Online article, "Thanks to efficiencies created, in part, by Dell's Web-based supply chain, the company can remain profitable even while it launches a bloody PC price war." In 2001, Dell unseated competitor Compaq Computer as the worldwide leader in PC sales.

FURTHER READING:

Jacobs, April. "Businesses Warm to Internet PC Sales." Computerworld. December 29, 1997.

Koprowski, Gene. "AOL CEO Steve Case." Forbes. October 17, 1996.

Mulqueen, John T. "Dell's Aiming to Take Corps to the Web." InternetWeek. December 22, 1997.

Shook, David. "The Winner of the PC Price Wars: Dell." BusinessWeek Online. May 1, 2001. Available from www.businessweek.com.

Simons, John. "Steve Case Wants to Get America Online." U.S. News & World Report. March 25, 1996.

Vogelstein, Fred. "The Talented Mr. Case." U.S. News & World Report. January 24, 2000.

SEE ALSO: AOL Time Warner Inc.; Apple Computer Inc.; AT&T Corp.; Compaq Computer Corp.; Competitive Advantage; Co-opetition; Dell Computer; Differentiation; Hewlett-Packard Co.; Microsoft Corp.; Netscape Communications Corp.; Sun Microsystems

COMPETITION

Competition is the term used by economists to describe the nature of the relationship between businesses vying against each other to sell their goods and services to consumers. McDonald's and General Motors do not compete with each other because a consumer's decision to buy a hamburger has no affect on his or her decision to buy a car. However, McDonald's and Burger King are competitors because a consumer's decision to dine at one involves a de facto decision not to dine at the other.

Economists have defined three major types of competition: perfect, monopolistic, and oligopolistic. The trout fishing industry is an example of perfect competition because trout are interchangeable as products, so trout fishing firms can only compete with each other by lowering prices. The computer operating system industry is an example of monopolistic competition because consumers purchase software programs that can only work on a single (firm's) computer operating system, (e.g., Windows, OS/2, Linex, etc). The automotive industry is an example of oligopolistic competition because there are only a handful of competing firms, the cost to break into the industry is prohibitive, and if one firm lowers its prices the others will automatically lower theirs. Oligopolistic firms, therefore, compete through advertising and customer loyalty.

Prior to 1815, U.S. businesses cooperated with each other to compete against the market outside the United States. Because of their religious beliefs, the harsh conditions of colonial life, and the sociallyoriented economic philosophy the United States had inherited from England, early U.S. entrepreneurs banded together to work out a "fair" price for their goods. From about 1815 to the end of the nineteenth century, however, advances in manufacturing, communication, and transportation technologies created economic capitals like New York and Chicago. Powerful new industries were born that opened up a huge new national marketplace where competing firms could gain advantage by undercutting each other's prices. This long period of industrial, price-driven competition led to the third age of U.S. competition and the birth of the corporation. By combining oil and steel firms, industrial leaders like J. P. Morgan (1837–1913), John D. Rockefeller (1839–1937), and Andrew Carnegie (1835–1919) built huge monopolistic enterprises that sought to manage prices and control competitive chaos. In the twentieth century, the federal government played a significant role in breaking up these monopolies and managing the economy. Of note, the emergence of the personal computer and Internet industries during the 1980s and 1990s seemed to herald a partial return to the spirit of competition of the nineteenth century.

See also: Capitalism, Andrew Carnegie, Free Enterprise, Monopolies, J. P. Morgan, John D. Rockefeller, Trusts