Competition; M. Peterson

550 use perfect competition as a static yardstick with which to measure dynamic competition in the real world. For example, Nobel Prize win ner Paul A. Samuelson in the eighth edition of his bestselling textbook, Economics, states: "The competitive model [of perfect competition] is extremely impor tant in providing a bench mark for appraising the efficiency of an economic system." He adds: "Once the rules of per fect competition are left behind, there is no Invisible Hand prin ciple which sets up a presumption that the working out of laissez faire is likely to be in the direc tion of satisfying wants most ef ficiently." The standard treatment of per fect competition by Professor Samuelson and other textbook writers usually sets up four re quirements: 1973 COMPETITION: THEORY VS. REALITY 551 1. Perfect knowledge of market conditions and instantaneous re source mobility (a requirement usually dropped as obviously un attainable and thereby resulting in "pure competition" - and it is pure competition to which Samuel son refers when he treats "perfect competi tion") 2. A large number of sellers in an industry (so large that none supposedly has any influence on price) 3. A standardized or "nondif ferentiated" product throughout an industry (thus, no brand names nor advertising) 4. Free entry (meaning rela tively costless admission of a new operating company into an estab lished industry) Having thus defined perfect competition, Eco. 101 textbooks generally describe the other mod els of lesser competition in terms of their failure to meet these four requirements. Thus "monopolistic competition" is basically pure com petition without the standardiza tion requirement met. Also, "oli gopoly" (from the Greek, meaning "few sellers") is basically pure competition without the many sell ers requirement met.

Naturally, the polar opposite of perfect competition is monopoly in ·Eco. 101 textbooks. Monopoly is said to consist of one seller selling a unique product (the product has to be unique because there is only one seller). And it also is said to be "protected" by high costs of entry, of which more later. The Number-of-Sellers Requirement So much for the textbook treat ment of perfect competition and its corollaries. Sadly, the treat ment is not just an ivory tower matter. Consider, for example, the num ber of sellers requirement as it is applied outside the classroom. This requirement is. largely the focus of modern antitrust policy. Indeed, Chief Justice Earl War ren stated in the landmark Brown Shoe decision (1962): "It is competition, notcompeti tors, which the [Clayton] Act pro tects. But we cannot fail to recog nize Congress' desire to promote competition through the protec tion of viable, small, locally-owned businesses. Congress appreciated that occasional higher costs and prices might result from the main tenance of fragmented industries and markets. It resolved these competing considerations in favor of decentralization."

Thus, modern antitrust policy, borrowing from classroom theory, prefers to maintain a relatively large number of sellers even at the expense of efficiency. This conflict between numbers and efficiency points up the essen552 THE FREEMAN September tial weakness of the number of sellers requirement under pure competition: Little is said about the determinants of the number of sellers. But consumer sovereignty, management ability, and econo mies of scale are important fac tors affecting the number of sel lers. The presence of few sellers may well be a sign of significant efficiency benefits for the consumer from mass production, mass dis tribution, and mass research. For example, the auto indus try, called an "oligopoly" in vir tually all textbooks, is actually quite competitive, despite the pres ence of a few domestic producers - GM, Ford, Chrysler, and AMC. In the early years of the twentieth century, there were literally hun dreds of small sellers. But the consumer - through Henry Ford - drove out many sellers, as Ford steadily reduced his costs through mass production techniques and dramatically lowered his price.

Surely this was competition, and the most basic kind - price com petition. Alas, however, Henry Ford would today probably be consid ered an imperfect competitor by most students taking Eco. 10l. Now he would also be faced by a gamut of antitrust suits, both public and private (from competi tors), much as is IBM today. Apart from efficiency considerations, other factors, which are omitted by the numbers require ment, enter into actual competi tion - Le., dynamic competition. For example, there are also un countable potential sellers not quite able to enter an industry entrepreneurs, usually in related industries, who are waiting for a rise in demand, a technological breakthrough, or some ineptitude on the part of the existing sup pliers, before joining the estab lished sellers. Rohr, an aerospace producer supplying San Fran cisco's BART rapid transit sys tem, is a case in point of a poten tial seller converting into an ac tual.

Competition is Market-Wide, Not Conlined to a Given Industry Another example of an omission in perfect competition theory is competition among individual in dustries. Interindustry competi tion exists because for any prod uct there is usually a range of substitutes. To his credit, Samuel son explains that pure competi tion theory excludes competition between industries such as steel and aluminum. Perhaps this omission by per fect competition theoreticians can be explained as the confusion of an industry for a market. The point of view of an "industry" is generally that of the seller; the 1973 COMPETITION: THEORY VS. REALITY 553 point of view of a "market" is generally that of the buyer. But the consumer, not the pro ducer" is sovereign. In the market place, it is the consumer's view that prevails. The buyer's market perspective includes a full range of choices available to him in all competing industries (and even in noncompeting industries in the sense that all industries compete for the consumer's dollar). Wit ness, for example, the demise of the once blue-chip streetcar indus try, which fell prey to the motor car, i.e., to the sovereignty of the consumer.

Or consider a personal example. Not long ago I had to get from Newark, New Jersey to Washing ton, D.C. I considered three op tions: driving a rented car, taking the air shuttle, or riding the Met roliner. To me, the sovereign con sumer, the three were very much in competition-interindusty com petition. This is but another ex ample of how in the eye of the con sumer a market inevitably trans cends an industry or even several industries. The forgotten Consumer But under the doctrine of per fect competition inherent in mod ern applied antitrust policy, the consumer plays second fiddle to the Justice Department. The consum er, for example, built up IBM, democratically; now the Justice Department seeks to tear it down, arbi trarily. Thus, the number of sellers re quirement in perfect competition variously conflicts with actual dy namic competition. The other re quirements do, too. Product dif ferentiation, for instance, is con sidered wasteful by many econo mists. They deplore the cornuco pia of choices available to the con sumer, although they might incon sistently deplore the lack of choice in, say, some development housing.

Here, again, theory is at odds with reality. A producer who strives for product innovation for quality competition, as opposed to price competition - is branded as an imperfect competitor. But are not attempts to improve prod ucts salutary? Many economists may not like quality competition, but consumers do. Take King Gil lette and his revolutionary safety razor of a half century ago, for instance. Here, technology and quality competition seemingly launched a "monopoly." But did it? Further, is it feasible for an economist of the imperfect compe tition school to enter the market place himself, so to speak, and de clare with all the weight of his academic credentials. that this product or that is or is not waste ful? Is it really in this economist's 554 THE FREEMAN September domain to pass a scholarly opinion on whether, say, the deodorant soaps of today, or even the tailfins of the 1950's, constitute "waste 1"

The individual consumer can bet ter decide such questions, for only the consumer knows exactly what he or she wants. (And this propo sition holds true for the sovereign corporate consumer as well - e.g., General Motors is a consumer of U.S. Steel and vice versa.) The requirement of free entry also does not correspond with com petition in the real world. Any en try involves cost, of course, as does all economic activity. But to posit a model of perfect competi tion in which the costs of entry are very low,·runs against common sense. According to this low-cost argu ment, economies of scale create a protectionist "barrier to entry" because of the heavy investment involved. Thus, mass production is doubly evil in the eyes of perfect competition: it reduces the num ber of sellers, and creates barriers to entry. But the contribution of economies of scale to lower prices tends to be played down, along with the fact that many firms with economies of scale can be overtaken (such as Ford by Gen eral Motors in the 1920's and Sperry Rand by IBM in the 1950's) .

Another example of a barrier to entry cited by quite a few econo mists is advertising. These econ omists pick on advertising - apart from its "wastefulness" - because new entrants must pay more in advertising costs than established sellers. True, but they must do so in order to win the consumer's ac ceptance. For new entrants, adver tising is frequently a vital means of gaining acceptance. Restric tions on advertising, which are recommended by some economists, would hurt new entrants and po tential competitors. Thus, all the requirements of perfect competition have severe shortcomings. In a word, all these requirements and their regula tory and other repercussions re flect a concept of competition that is essentially static. But actual competition is dy namic, not static. The dynamics include the reduction of costs by mass production techniques and new technology, the competition from substitute products, the com petition from potential sellers, and the incentive of sellers to improve their products - all under the most dynamic factor of all, the watch ful eye and hard decision of the consumer, individual and corpo rate.

In sum, the conflict between classroom theory and business re ality in our understanding of com petition is anything but academic. ~ R. W. DEMERS THE MAN with the hoe slowly straightened his arched back. Tak ing the straw hat from his head, he wiped away the beads of sweat from his forehead with the back of his dusty hand. Slowly he moved out of the heat of the sun into the shade of a great maple tree growing between his garden fence and a country road. As he stood in the comforting cool, surveying the lush, green, orderly rows of his garden, a neighbor, driving by, pulled up close to the fence and also took note of the neat, and abun dantly fruitful garden. He turned to the man in the cool shade and nodding his head with fine approval toward the garden, he said with profound authority: "Yes sir, a mighty fine garden, you sure are a lucky man!" The gardener replaced his straw hat, lifted his hoe, and with a singular, "Yup!" moved Mr. Demers is a vocational counselor in Veneta, Oregon.