Competition In Economics

"Competition ensures efficiency. The role of government should therefore be to ensure that competition prevails."

The first part of the essay will discuss the link between economic competition and efficiency, elaborating the concepts of perfect competition and Pareto efficiency. It will explore to what extent competition ensures efficiency. The title implies that governments should ensure competition in order to achieve efficiency, therefore the second part of the essay will consider whether efficiency is a good thing. I will argue that efficiency is indeed a good thing, therefore governments should ensure competition prevails.

Pareto efficiency is a circumstance or set of circumstances in which any benefits accrued by a party or individual must result in losses to another party or individual. It is a useful concept in economics because if one considers a situation that is not Pareto efficient, then it is the case that there is a different allocation of resources that will result in a Pareto improvement i.e. an improvement that does not cause anyone to be worse off than before. The economic system or set of rules that best achieves Pareto efficient allocations is perfect competition. By perfect competition, I mean an idealised market system with conditions that include consumers and producers having perfect information, there being a large number of buyers and sellers of homogenous products, and no agent having the ability to affect the market price of a good. In a perfectly competitive market `efficiency is achieved because the profit-maximising quantity of output produced by a perfectly competitive firm results in the equality between price and marginal cost`1. MC=Price is a Pareto efficient outcome because the benefit gained by production of the good (represented by the price) is equal to the opportunity cost of producing the good (represented by the marginal cost). In this way, there is no re-allocation of resources to the production of other goods that will result in a Pareto improvement (productive efficiency). In the long run, allocative efficiency is achieved as firms enter and exit the industry in order to maximise profits. This means that market price is equal to long run marginal cost and long run average cost, firms earn normal profits and there are no economic losses.

It is true that markets in actual economies don`t resemble closely the perfect competition model. Real markets have asymmetric information, various barriers to entry, heterogeneous products, negative and positive externalities that are not captured by price, and a degree of monopoly and monopsony power. However, the perfect competition model illustrates some key conditions required for an efficient economy, conditions that governments could work hard to ensure. Evidence to suggest that governments could promote perfect competition conditions is the presence of internet markets. Some markets on the internet come close to the perfect competition model (In the market for unbranded boxing skipping ropes on eBay, the number of sellers is astounding. Listings are ranked in terms of price/reviews thus giving consumers close to perfect information. The price including postage of unbranded ropes is around £1.50 which will be very close to minimum average cost.)2. One can imagine a future in which most goods and services are bought and sold on the internet, thus an almost perfectly competitive economy. Having established the link between competition and efficiency, and having suggested that governments could, to some extent, ensure conditions similar to those in a perfectly competitive economy, the question remains whether the government should ensure competition and thus efficiency.

Pareto efficient outcomes seem attractive. The idea that, through competition, improvements can be made without worsening the situation of others is a powerful one. However, Pareto efficient outcomes are not necessarily desirable. Pareto efficiency would support inequitable distributions of resources e.g. it would be a Pareto improvement to magically make 10% of the UK population infinitely richer than the rest. Some would consider this an undesirable outcome. Pareto efficiency also doesn`t allow for rankings of Pareto efficient outcomes, ultimately it tells us little about how economic benefits should be distributed. It doesn`t take account of positive and negative externalities. However, some of these issues can be partially solved by considering the Kaldor- Hicks efficiency criterion, which takes into account whether re-allocations would still occur if third parties could be compensated for any negative consequences of the re-allocation. Moreover, if individuals` concerns about equity and societal welfare could be expressed in their utility functions, then allocations that were inequitable may not be Pareto efficient and thus not be reached through competition (consider a competitive market for charities, consumers` utility is tied directly to inequity and the utility of others). ?

The positives of economic efficiency greatly outweigh any negatives. Low prices, thus decreased costs of living, increased entrepreneurial activity and technological innovation, and simply the idea that through competition, mutually beneficial transactions can occur that effectively create utility that previously didn`t exist. Whatever people believe the role of government to be e.g. maximise total happiness, minimise the worst suffering, in theory, competitive markets will reflect these political preferences and achieve political ends far more effectively than government methods of planning and control. In this way, it seems that if governments intend to reflect the preferences of their citizens, then it should ensure competition. ?