Understanding Competition
Understanding competition is critically important to explaining economic phenomena. Competition is important to the functioning of society, and understanding it allows one to explain previously confusing phenomena.
Competition occurs in phases.
1. First a new product is invented. It's inventor and the entrepreneurs investing in it are the only producers of that product. If the product is useful to society, the inventor will earn profits as people buy the new product that they didn't have access before. The profits compensate the inventor for their costs of invention, plus they serve as a reward to encourage all the other inventors who may not come up with anything useful, but who still spend a lot of time and effort trying.
2. The high profits in the new product attract entry from competitors. Competitors don't have to make the same exact product, just something close enough to attract customers. Production capacity in the industry expands. Since demand curves slope downward, price must fall and/or quality must increase.
3. Once prices are low, competition holds them there, since any firm raising prices loses business to a firm who maintains them. Competition is a prisoner's dilemma. Firms lowering prices/raising quality temporarily get high profits as customers flock to them and away from their competitors. Over time, however, their competitors have to lower prices/raise quality to match them and the winner is the customer. Each firm would like to raise prices, but when there are many firms competing, it is very difficult to get everyone to work together. Additionally, making an agreement to raise prices is a criminal (not civil) offense - the CEO can get thrown in jail. That makes it hard for more than a handful of firms to maintain. Firms need to create an agreement on what is to be done - what the precise price level should be. A fuzzy arrangement will lead to each member slowly dropping their prices to gain an advantage over the others. Secondly, they need to create an enforcement mechanism to punish those that break their rules. In social organizations where violence is common, the enforcement mechanism won't be too hard to come up with, but since in America, a defecting company can get the police to shut down their rivals if they turn state's evidence, it can be hard to maintain a good punishment system. The punishment system could be a tit for tat price drop, but that may degrade into outright competition.
Competition is an evolutionary system. It has selection (bankruptcy), variation (entrepreneurs) and inheritance (profits). Over time, successful companies grow and attract new competition. Unsuccessful companies die out, freeing up resources for more efficient firms in a process dubbed "creative destruction." Adjustments can be difficult for individuals, but over time society benefits with each step. Without change, there is no growth. Products people never expected to be profitable might work, products everyone thought would be great have failed. Capitalism is turbocharged chaos, but chaos and evolution produce order far greater than any human mind could possibly comprehend, for example, the human mind itself.
One consequence of thinking in terms of competition is that you know where to look for evidence of things. If an industry is competitive and prices go up, you don't need to waste time with conspiracy theories of evil corporations. You can instead look for either supply or demand shocks. If someone tells a story about exploitation, ask "where are the excess profits?" Firms that are in competitive markets will be driven out of business by non-discriminatory firms, since non-discriminatory firms will be able to hire discriminated-against workers at a discount, gaining a competitive advantage.
There are a few things needed for competition to work. Competition must be a non-coercive non-violent endeavor. Violence allows cartels to effectively punish one another for lowering prices, allowing collusion. Violence is inherently destructive, and the more resources spent fighting over scarce resources, the fewer resources available for satisfying people's wants and needs. Competition requires property rights to be enforced and well defined. If people know they will profit from working hard, they will work harder. Societies have collectively starved themselves rather than let someone else take the full benefit of their efforts. Property rights encourage investment, since people know they can expect to gain from improving their property. Markets also require contract enforcement. Companies need to have a legal framework to ensure people keep their promises and don't renege on deals. Finally, competitive markets require a culture that is open to fair dealing, honest, and has little envy. Laws are only as good as the norms that back them with some wiggle room for coercive enforcement. With these factors in place, competitive markets will produce steadily increasing prosperity.
Competition occurs in phases.
1. First a new product is invented. It's inventor and the entrepreneurs investing in it are the only producers of that product. If the product is useful to society, the inventor will earn profits as people buy the new product that they didn't have access before. The profits compensate the inventor for their costs of invention, plus they serve as a reward to encourage all the other inventors who may not come up with anything useful, but who still spend a lot of time and effort trying.
2. The high profits in the new product attract entry from competitors. Competitors don't have to make the same exact product, just something close enough to attract customers. Production capacity in the industry expands. Since demand curves slope downward, price must fall and/or quality must increase.
3. Once prices are low, competition holds them there, since any firm raising prices loses business to a firm who maintains them. Competition is a prisoner's dilemma. Firms lowering prices/raising quality temporarily get high profits as customers flock to them and away from their competitors. Over time, however, their competitors have to lower prices/raise quality to match them and the winner is the customer. Each firm would like to raise prices, but when there are many firms competing, it is very difficult to get everyone to work together. Additionally, making an agreement to raise prices is a criminal (not civil) offense - the CEO can get thrown in jail. That makes it hard for more than a handful of firms to maintain. Firms need to create an agreement on what is to be done - what the precise price level should be. A fuzzy arrangement will lead to each member slowly dropping their prices to gain an advantage over the others. Secondly, they need to create an enforcement mechanism to punish those that break their rules. In social organizations where violence is common, the enforcement mechanism won't be too hard to come up with, but since in America, a defecting company can get the police to shut down their rivals if they turn state's evidence, it can be hard to maintain a good punishment system. The punishment system could be a tit for tat price drop, but that may degrade into outright competition.
Competition is an evolutionary system. It has selection (bankruptcy), variation (entrepreneurs) and inheritance (profits). Over time, successful companies grow and attract new competition. Unsuccessful companies die out, freeing up resources for more efficient firms in a process dubbed "creative destruction." Adjustments can be difficult for individuals, but over time society benefits with each step. Without change, there is no growth. Products people never expected to be profitable might work, products everyone thought would be great have failed. Capitalism is turbocharged chaos, but chaos and evolution produce order far greater than any human mind could possibly comprehend, for example, the human mind itself.
One consequence of thinking in terms of competition is that you know where to look for evidence of things. If an industry is competitive and prices go up, you don't need to waste time with conspiracy theories of evil corporations. You can instead look for either supply or demand shocks. If someone tells a story about exploitation, ask "where are the excess profits?" Firms that are in competitive markets will be driven out of business by non-discriminatory firms, since non-discriminatory firms will be able to hire discriminated-against workers at a discount, gaining a competitive advantage.
There are a few things needed for competition to work. Competition must be a non-coercive non-violent endeavor. Violence allows cartels to effectively punish one another for lowering prices, allowing collusion. Violence is inherently destructive, and the more resources spent fighting over scarce resources, the fewer resources available for satisfying people's wants and needs. Competition requires property rights to be enforced and well defined. If people know they will profit from working hard, they will work harder. Societies have collectively starved themselves rather than let someone else take the full benefit of their efforts. Property rights encourage investment, since people know they can expect to gain from improving their property. Markets also require contract enforcement. Companies need to have a legal framework to ensure people keep their promises and don't renege on deals. Finally, competitive markets require a culture that is open to fair dealing, honest, and has little envy. Laws are only as good as the norms that back them with some wiggle room for coercive enforcement. With these factors in place, competitive markets will produce steadily increasing prosperity.