Competition has remained as one of the most endeared words in popular economics. In common parlance, it is an ideal to which economic policies should be directed, and an industry’s pliability to competition is thought of as universally valuable. When critics of the economic systems that be maledict the status quo in economic terms, more often that not, it is due to a perceived lack of competition and thereby presence of monopoly; as well, critics of various nationalizations warn of the lack of competitiveness that a public monopoly can confer to a firm. It is a playful idea that large businesses go head to head for the benefit of the people, and the model of perfect competition is taught as the default and purest form of economic reality.
These perceptions are not entirely accurate. It is not true on an objective level that perfectly competitive industries are most desirable due to their assumed universal excellence; more than that, there can be made a quite persuasive subjective argument that monopolies and monopolisticly competitive market frameworks are more socially beneficial than their "perfect" sibling. Most importantly, perfectly competitive industries are most notable by their distinct lack of existence apart from the theoretical machinations of the pondering economist. Any practical dealings, therefore must be aimed at "less-competitive" frameworks.
Perfect competition is a model which in many respects has overstepped its rightful place in the public mind. Its limitations and environment must first be understood; these limitations, often expounded upon in elementary economics, seem to gradually fade away in the mind of the maturating economic think, but they are no less necessary to highlight:
1. The products sold in a market in perfect competition must be perfectly homogenous in quality. The quality of the goods is assumed to be the same with ceteris paribus. The only way therefore that producers can push consumers to purchase more of their product is by lowering the price. On the diagram of the perfect competition, the only variables are price and quantity; all other factors must be the same.
2. Consumers must be aware of the above and the nature of the market. Even if firms sell an identical product, consumers must know this to be so before it has any bearing. A firm selling a homogenous product could still advertise and publicize itself to increase the number of purchases of said product; it that were so, the industry would not be perfectly competitive. Consumers (and producers) must have perfect knowledge of what their profit maximizing decisions would be and must be able to see goods without being given irrational preferences by advertising.
3. There must be many buyers and sellers of products. In a market of one or few firms, producers could easily collude and multilaterally increase prices. This must not be so for perfect competition to be efficient.
4. There must be no barriers legal or monetary to entry or exit into or from the industry. In order to keep the market competitive, new firms must be able to freely enter the industry to provide competition. If an industry which theoretically functions under perfect competition has only several firms, new one should be able to enter to drive down prices.
In perfect competition, we can see that neither consumers nor producers have any effective bearings in the market price. Because of the multiplicity of producers, individual firms are unable to price their product above the equilibrium price; if they did, consumers with their perfect knowledge would refuse to buy the super-equilibrium products. Firms are in a position where they only accrue sufficient revenues to cover production costs, and if the market price fluctuated below the perfect equilibrium, all firms would have to shut down for their profits would be negative and they would have no incentive to continue in the market.
So in the ideal of perfect competition, prices are “naturally” decided and no one man has any power to sway the market in his favor. Lauders of perfect competition oft favor it for this neutrality; it cannot be manipulated by the unilateral greed of people or businesses. But the important question to ask is whether or not PC is something that exists in real economic life.
There are some industries that closely mirror perfect competition, yet not in the utmost preciseness. Ibuprofen along with other pharmaceuticals, may be mostly homogenous products, but various companies try to create brand loyalties and differentiate their product from others (Advil, Motrin, Addaprin, and dozens of others); when consumers show a preference for one over another based on advertising, the market is not acting as if it were perfectly competitive. Most agricultural businesses vend a nearly identical product; consumers have little preference which company produces their wheat or picks their apples. Still packaged food products manage to cater to individual consumers' sensibilities: Goya may may aim to specifically evoke the brand-loyalty of Hispanic buyers, or some companies label their goods as "all-natural" or " organic" in attempt to cater to some cultural subgroups. Pizza companies have various options: perhaps one firm will parade their alleged Italian authenticity, while another makes casually packaged yet identical pizza aimed at young people.
Now groceries and medicine may be nearly perfect competition, but the vast majority of products that consumers encounter on a daily basis are not in the slightest. When people say, go to eat at fast food, they are dealing with fully differentiated products. Various hamburgers may be loose substitutes for each other, but sales of Whoppers would not fall to zero if it were priced at a cent above Big Macs, as predicted by perfect competition. Now if McDonalds were to open a new 50¢ menu and other competing firms couldn't keep up with the depricing, we can expect a significant fall in the sales of other burger joints, but if the market were perfectly competitive, all other firms would fall out of business.
Monopolistic Competition
This brings what we already implicitly know to the forefront. The firms with which we deal on a daily basis do not match the precepts of the model of perfect competition at all. We can see however a loose inverse correlation between the demand for competing products; still firms have the ability to change prices without losing the whole of their sales as predicted by the perfect competition model.
Edward Chamberlin was one of the first to conceptualize this. He noted that firms have a tendency to differentiate their products in this said manner, thus violating the first requirement for a perfectly competitive market listed above. This allowed businesses to "monopolize" a certain good and they would be able to advertize with the knowledge that capital used in advertizing would not furnish the appearances of other related goods.
If Charmin runs commercials speaking about how soft and effective their toilet paper is, due to differentiation, consumers typically do not overgeneralize the advertizement to Angel Soft or Scott or Cottonelle. Now we can assume that demand for toilet paper is relatively constant per capita (i.e. people are not instilled with a desire to defecate more having seen toilet paper commercials). This means that advertizing only affects sales between firms, not industries. This allows firms to price their products differently while some firms may aim their goods to a different economic niche.
Now admitting the lack of existence of perfect competition may imply various things. For those who have viewed it as a unequivocal economic good, the outcome might be obvious: that the government in that case should encourage producers to produce identically made and packaged food or that all businesses should have the right to sell others' labels, these recommendations matching the idea that PC should be the goal of government policy in market competition.
Of course such considerations seem far to strict, but most of the exertion of force at the hands of public policy has been to aliken markets to this "perfect" ideal, even if not perfectly. We do realize that the more monopolistic an industry may be at a given time, the higher the prices are likely to be held, and because this is nigh universally distasteful, policy has been taken to shove markets into more competitive states.
Schumpeter
Now even if our beloved perfect competition is not as ubiquitous as we would wish it to be, one must estimate if, because the economic world has not fallen apart, imperfect models of competition may be equivalently socially beneficial as perfectly competitive ones, perhaps if we shall just out far enough in contemplation, even that imperfect markets are preferable to perfect ones. More prominent noter of this was Joseph Schumpeter who would speak about the fundamental divergences between monopolistic and perfect competition. The primary effective difference is that an industry hypothetically in perfect competition earns no economic profits and must charge the smallest possible price for its goods; monopolistically competitive industries, and monopolies for that matter, have enough wiggle room to charge prices that earn themselves profits which in the perception of most are at the expensive of consumers. But what Schumpeter suggests is that the idea that economic profits are suboptimal for consumers and society is quite short-sighted and relies too much on the models built at an instant in time:
“In analyzing such business strategy ex visu of a given point of time, the investigating economist or government agent sees price policies that seem to him predatory and restrictions of output that seem to him synonymous with loss of opportunities to produce. He does not see that restrictions of this type are, in the conditions of the perennial gale, incidents, often unavoidable incidents, of a long-run process of expansion which they protect rather than impede. There is no more of paradox in this that there is in saying that motorcars are traveling faster than they otherwise could because they are provided with brakes.”
Schumpeter’s main contention was that, although perfect competition creates an equilibrium that is at all times efficient, this does not mean that in the long-run constant equilibrium is optimal itself. Under perfect competition, firms find themselves with absolutely no economic profits, only with enough revenue to continue their business into the following cycle. Under this, consumers may garner the highest possible consumer surpluses at every point in time, but firms are lent no leeway in research and development, no extra capital to hedge against the unknown, and no possibility of avoiding the characteristics of depression. Industries which face competition closest to the “perfect” model, like most small-time farmers which sell identical products, often are keenly associated with economic poverty and a disability to innovate. The nature of this industry leads to businesses without the ability to save savings comparable to other industries because firms have no practical ability to increase the price of their goods unilaterally. Over time, innovation could result in superior products and better methods of transporting them to market, thus an increase in utility for consumers as well, yet in perfect competition it is infeasible to do this.
So this innovation, which comes at the continual short-term expense of the consumers, aids in creating a society in which effective quantity and quality of goods supplyable to each consumer increases endogenously over time. Contrary to PC, there is never an "optimal" in the economic sense, firms are always charging more than needed to produce, but the new profit creates circumstances in which effective livability increases over time. PC offers an optimal, yet stagnant economic world, whilst non-perfect competition allows firms to innovate in Schumpeter's ideal.
The competition of importance in commercial society to Schumpeter was not the kind between firms, but the kind between products, which occurs, to his perception, on an interfirm and an intrafirm basis. In this, the status of an industry as perfectly competitive or monopolistic is mostly irrelevant; the improvement in the standard of living comes not from the number of throat-cutting firms, but the amount of new and innovative products. When new products enter the economic arena, they not only disturb the profits of competition firms, but of substitute products produced by the innovating firm themselves.
Of course innovation is more achievable in a market framework in which firms do indeed have access to economic profits, so in this sense, it is the monopoly or the monopolisticly competitive industry which is more capable of funding technological development which ameliorates their economic condition and thereby the products available to consumers.
With this said, saying that perfect competition is socially optimal is comparable to saying that the best thing a worker can do with his wages is immediately spend their entirety. A worker could graph his potential daily surplus and see that to maximize it every day, he must use his money-wages as quickly as possible. This idea, like the model perfect competition accounts only for the split second for which the graph is drawn up and ignores the firm’s or this worker’s ability to save and invest in potentially more utilitarian ventures. This makes any direct conclusions drawn from the model bear only instantaneously.
So really a industry's capability to gain profits is equivalent to a worker's ability to retain an amount of disposable income. Both need both for long term capital (human or physical) improvement, but if either are subject to a perfectly competitive market, they lose such abilities. Indeed the reason that Ricardo suggested his Iron Law of Wages is because operating in the framework of perfect competition in the labor market, it was obvious that workers would need to compete with each other until their wages reached a bare subsistence level.
The Tradeoff
With all of this acknowledged, the important tradeoff that must be highlighted is that between low prices currently and increasingly lower ones in the future. The advantage of a monopolisticly competitive industry or a monopoly is that they needn't slash prices until they reach a "subsistence" level of non-profit, and thus can indeed provide for future development. This obviously does not mean that any level of profit is appropriate or socially optimal just as well as any level of personal savings is desirable. Instead one must acknowledge that society (or the market si licet) needs to produce a savings/investment/profit rate that can provide for the future while not force all contemporary people into miserable lives.
We could easily say that all social profits produced by a firm should be rewarded to itself; yes, this would eventually come back in the form of endogenous innovation. But one could, with the same facility say that an individual should save 100% of his income to make investments in his future. Certainly both investments shall pay off in the future, but we must recognize our necessary discount rate necessitates that we choose a level of profit or savings lower than this not-so-idealistic ideal.