INTERMEDIATE MICROECONOMICS

4. Competition

4.1 Terms & Assumptions

Index

1. Competition

2. Markets

3. Equilibrium

4. Rules of the Game

1. Competition

The word 'competition', in English, comes from the late Latin competitio or rivalry.  In first presenting Consumer Theory (1.2) and then Producer Theory (1.3), some might suspect that Competition (1.4) would simply pit consumer against producer in bargaining, haggling or rivalry about the price/quantity/quality of goods or services sold in exchange for consumer income earned through the disutility of work.

In actuality, this ultimate consumer/producer rivalry has twin roots:

(a) consumer vs. consumer as rivals for a finite supply of final goods and services expressed in their willingness to pay as a function of taste, income and prices; and,

 (b) producer vs. producer as rivals for scarce factors of production including brand recognition, location, talent and technology expressed in their willingness to sell as a function of factor cost, scale and technology.  

There are thus three frontiers of economic competition:

i - consumer and consumer;

ii - producer and producer; and,

iii - consumer and producer.

In Institutional Economics there is also a silent partner, or referee, in this three-ring circus - government and, more specifically, the probability that governmental agents, e.g. the courts, will keep the rivalry within legal if not ethical bounds (see:  The Legal Foundations of Capitalism - Chapter VII: The Price Bargain, 1924, MacMillan, NYC, 1939; Institutional Economics, American Economic Review, Vol. 21, Issue 3, Dec. 1931, 648-657; Institutional Economics, American Economic Review, Vol. 26, Issue 1, Mar. 1936, 237-249; and Institutional Economics (1934), University of Wisconsin, Madison, 1959 ).   In this tradition, there are five  players in any economic transaction whose roles sum up the 'opportunity cost' nature of economics:

i - the actual buyer;

ii - the next best buyer;

iii - the actual seller;

iv - the next best seller; and,

v - the State.

 

2. Markets

Markets are the ring in which all three forms of competition take place.  In brief, a market is any arrangement whereby buyers and sellers obtain information about each other, and then do business, i.e. make exchanges of money for goods.  Put another way, markets are where demand meets supply.  Markets can be described by reference to:

- whether they are geographic or commodity-based;

- whether or not they are in equilibrium and, if so, what type of equilibrium;

- their sensitivity to change (elasticity) in prices and incomes; and,

- whether or not anyone consumer, producer or government can influence price or, more generally, the terms of trade or exchange.

Market demand (M&Y 10 Fig. 5.1; M&Y 11th Fig. 4.1; B&B not displayed; B&Z not displayed) is the horizontal summation of individual utility functions.  Mathematically this market demand tends to veil the underlying rivalry between consumers.  Similarly, market supply (M&Y 10th Fig. 9.5; M&Y 11th Fig. 8.6; B&B not displayed; B&Z not displayed) is the horizontal summation of each firm's supply curve (marginal cost above minimum average cost - M&Y 10th  Fig. 9.3 & 9.4; M&Y 11th Figs 8.4 & 8.5; B&B Fig. 9.2; B&Z Fig. 9.5).  Expressed in mathematical terms it too tends to veil the intense underlying rivalry between firms.

Expressed in terms of consumer vs. producer, in a market, price acts as a regulator of the quantity of goods and services demanded and supplied.  If the price is too high, consumers will demand less than producers are willing to supply. If the price is too low, consumers demand more than producers are willing to supply.   This is called 'market equilibrium' (M&Y 10th Fig. 9.6; M&Y 11th 8.7; B&B Fig. 9.9) in that there is a tendency for the price (and quantity) to gravitate towards the intersection of the demand and supply curves.
 

3. Equilibrium

Equilibrium is a condition which once achieved will continue indefinitely unless one of the variables (economic or non-economic) is altered. In the case of markets, the equilibrium price 'clears' the market, that is the quantity demanded by consumers equals the quantity supplied by producers.

More generally, economic theory recognizes three types of equilibrium:

i - general equilibrium: can exist under perfect competition and monopoly or monopolistic competition. Under perfect competition, it is a static state where all prices are at their long run equilibrium, individuals are spending income to yield maximum satisfaction, and the demand and supply factors of production are equated . Under monopoly or monopolistic competition, it is the situation where there is no reason for firms to enter or leave an industry, or to expand or contract;

ii - stable equilibrium: a condition which once achieved continues indefinitely unless there is a change in some non-economic conditions. Changes in economic conditions will be followed by reestablishment of the original equilibrium. Example: ball resting at the bottom of a cup; shake it and the ball returns to the bottom; and,

iii - unstable equilibrium: a condition which once achieved will continue indefinitely unless one of the variables (economic or non-economic) is altered, and then the system will not return to the original equilibrium and will not come to rest unless there is further alteration of a variable. Example: ball resting on the top of an overturned cup - shake it and the ball falls off never to return to the same place.

4. Rules of the Game

Economic competition takes place subject to 'rules of the game' established by the State not the market.  Even if the State chooses not to intervene but sets 'business free' there remain bankruptcy and contract laws that business cannot do without.  In effect even a State that claims to believe in the 'free market' must, nonetheless, legislate it into existence.  Some obvious examples of markets that can only exist because of State action are intellectual property rights - copyrights, patents, registered industrial designs and trademarks.

In addition to creating markets subject to differing national legal systems, the State also legislates consumer/producer relationships, e.g. product liability; producer/producer relationships, e.g. anti-trust or anti-combines or competition policy; and, to a lesser extent, consumer/consumer relationships, e.g. non-discrimination legislation.

So behind the facade of mathematical economics lays:

i - the changing, envious, rivalrous, swirling, twisting passions or preferences of consumers;

ii - the economically deadly rivalry of firms struggling to gain an upper hand by fair means or, sometimes, foul;

iii - the organized campaigns of taste creation and manipulation of consumer preferences by firms; and,

iv - the State that set the rules of the game and lays out the playing field subject to political exigencies.

 

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