On Competition and Markets

From a broad philosophical perspective, competition is encoded in the basic DNA of the universe. At every level of analysis, competing forces seek domination. At the largest inanimate scales, gravitational and electromagnetic forces constantly compete in stars. At the smallest scales, inside an atom, nuclear and electromagnetic force compete. In the biological world, living things compete all the time. It’s a constant battle between and among botanical and zoological species. Humans, as part of the animal world, are past masters of the game. We, like all other living organisms, are all descendants of ancestors who were successful in that competition at least long enough to have survived to reproduce.

Individually and at every level of human organization, we humans compete. As members of tribes or nations, as followers of religions, as employees of firms, as members numerous social organizations — we are also hardcoded to compete. We compete in an almost infinite variety of marketplaces — from getting a mate to winning an auction. Not just in the material sphere, we compete in the marketplace of ideas.

Even as individuals, we are not undivided. Within us there are competing forces fighting for dominance. Do the laundry or surf the web or write an essay? Our present needs and desires compete with that of our future selves. Get some exercise or watch TV?

It is hard to get away from the conclusion that competition is as fundamental a feature of our universe as are space and time. Indeed competition is guaranteed anywhere there’s a shortage of resources — and time is the most binding of all resources. If we had infinitely long lives, we would not have to compete either with others or within ourselves.

So competition is unavoidable and ubiquitous. But is it good? That depends on whether the focus is on the individual or the collective. Competition is never good for the individual but I think (believe, feel, suspect, conjecture, assert) that for the collective in the long run it is a good thing. That brings up the question as to what is the good that competition promotes.

Let’s take a concrete case. Consider the competition between predators and preys. It is never good for any individual prey — it gets eaten in the game. But only in the presence of predators does the prey as a group become better at survival. Of course the game does not stop there, as the predators also continue to evolve and become better (in some sense.) Perhaps in the long run it is a zero sum game as no party really “wins.” Or perhaps it is a positive sum game since in the long run both parties “win” in the sense that they evolve to be more complex entities.

Be that as it may, win or lose, what’s certain is that there is no getting out of this competition game. Being a basic feature of the universe, it cannot be outlawed or even controlled. It is my belief that attempting to control competition is not only futile, it is actually harmful and socially counterproductive. Which brings me to the point of this piece which deals with competition in the economic sphere. The arena where economic competition occurs is called the market. I wish to argue that societies that try to curb competition lose the benefits of competition and end up impoverished. Avoid taking the market route and you will have to take the road to poverty and serfdom. Why is that? Trying to curb competition is futile. Being a basic feature of the universe, it cannot be suppressed. It shows up elsewhere and in form that is damaging to social welfare.

Markets and Competition

To save time and avoid being pedantic, let’s just assume that we share a common understanding of what a market is. Much of our buying and selling happens in markets, whether it be labor, stuff such as food or services such as haircuts. Most of our exchanges are mediated by markets but not all: within households, we avoid the market mechanism and instead take the “command and control” route. Why we are able to dispense with markets within the family is an interesting question which need not detain us now.

From an economics point of view, markets and competition are innately fascinating phenomena. Markets are where competition takes place but whereas competition is natural since it is in-built into the universe, markets are not natural. They are human artifacts. Markets are artificial and don’t exist in the natural world. They have to be invented by humans. Among the great apes, humans are the only ones who use markets for the exchange of goods and services (if you discount the fact that some great apes do engage in some kind of primitive exchanges.)

Markets as an idea is an invention but they arise spontaneously whenever there is competition. Consider any natural resource, say water or land. If the supply is so great that there’s virtually an unlimited amount available for everyone’s needs, there is no scarcity and therefore no competition, and thus no market for that resource. There is no market for ice in the Antarctic or for sand in the Sahara. The moment demand reaches a level that needs come into conflict, markets come into being to ration the supply. Markets ration limited supply.

Every instantiation of the abstract idea of the market has to be engineered or created. Markets come into being when demand exists. There’s a market for land around the world today. But that idea of land being bought and sold would have been preposterous to a nomadic people living on a vast unpopulated territory. Even a few decades ago, carbon credits would not have made sense to most people. But now a global market for carbon credits is coming into being.

Scarcity and competition for the scarce good are required for markets to exist. And one more thing. Markets can be outlawed. There was a market for humans where slaves were bought and sold. Now it’s illegal in most economically developed countries. You cannot buy or sell human organs legally in most countries. Note that the legal boundary between the legal and illegal shifts. The legal market for alcohol, for example, was abolished during the prohibition era in the US. But of course because the demand for alcohol could not be abolished by law, the market simple went underground. Therein lies a lesson: demand cannot be suppressed by law and competition cannot be legislated away. They just move elsewhere. More about this later.

Competition IN the Market

The two essential competing participants in any market are buyers and sellers. Let’s be very clear where the competition in markets occur. It is not that buyers compete with sellers. In a market, buyers compete with buyers on the one side, and on the other side, sellers compete with sellers. Where there are many buyers and many sellers in a market, the outcome of the operation of the market is socially good and optimal. Under a few assumptions that are easy for us to understand, the optimality of such markets can be mathematically demonstrated. (That’s called the First Theorem of Welfare Economics.)

In the case that there is only one seller (such a market is called a monopoly), there’s no competition in that market. The result of that market is socially suboptimal. That’s basic Econ101. In a market with only one buyer (monopsony) and many sellers, the result also is suboptimal. Then there are other cases in between — a duopoly (two sellers), or an oligopoly (a few sellers) — which also produce results that are not as optimal as a perfectly competitive market (a large number of buyers and sellers.)

As noted before, sellers compete with each other in the market. Let’s underline that bit: they compete IN the market with each other. And because of that competition, the buyers gain. The simple way to think about this is to consider what motivates a seller. It is profit. Profit is the difference between their cost and their revenue. Competition ensures that the sellers whose costs are above the market price (which is what determines the revenue) will exit the market. Competition also ensures that prices will be close to the costs. An intuitive argument for this is that buyers will buy from the cheapest sellers and competition among sellers will drive the prices down to the costs.

The thing that most Econ101 students find hard to comprehend at first is that in a competitive market, sellers don’t make any (economic) profits. Basically they just break even. Being in a competitive market is the worst thing to be for a seller. Competition in the market is a bad thing for sellers.

So what’s the alternative? Simple: drive your competitors away. How? Get the government to restrict entry into the market!

The Source of Public Corruption

In the next bit, we will see how competition shifts from being IN the market to being a competition FOR the market. This distinction between competition in the market and competition for the market is important because it determines very powerfully the balance of power between the consumers (the buyers), the producers (the sellers) and the government (the third party that has the power to coerce others.) When producers are forced to compete in the market, the consumers gain. If the producers are able to persuade the government to limit the competition in the market, the producers then compete for the market and to do that they have to pay the government. This payment has to come out of the profits that they make in a protected market (profits that they would not have made in a competitive market.)

Public corruption — the kind that we have pretty much gotten sick of hearing about — is primarily a consequence of government power that shifts competition in the market to competition for the market. That story coming up next.

(Continued in “Competition and Markets — Part 2“.)

{This is an excerpt from a work in progress book on basic economics.}

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