A Few Thoughts on the Importance of Competition and Markets

Hi Everyone,

We cannot solely rely on ourselves to meet all our desires (needs and wants). As people and societies have grown and evolved, we have become more dependent on other people to fulfil or at least partially fulfil our needs and wants. To obtain help from other people, we need to provide something in return. We could provide a good or service in exchange for a good or service that contributes to fulfilling our needs and wants (e.g. barter trade). However, in complex societies direct exchanges are rarely possible. It is unlikely that the person/people who are offering the goods and services that we want, desire the goods or services we are providing. Therefore, for ease of trade, we need a medium of exchange (e.g. money) that can be easily transferred between people.

Trade

The needs and wants we cannot satisfy ourselves are satisfied through trade. We trade our money for goods and services that we believe most closely satisfies our needs and wants. Businesses provide these goods and services because people want them (e.g. supply meeting demand). Businesses have opportunities to earn revenue when people are willing to pay for goods and services they want. They can use their revenue to pay for the costs of providing the goods and services. For example, businesses often employee people; they pay these people a salary. The excess revenue over costs becomes profit (measured in a currency). Money as profit and salaries can be used by businesses owners and employees respectively to trade for goods and services that they believe most closely satisfies their needs and wants.; a basic economy has been formed.

Economies will form naturally. They will become widely interconnected as people become dependent on each other for many of their needs and wants. Dependence is caused by specialisation, division of labour, and reduced scope of work. Many people are focused on producing just a few outputs or play a part in generating another output. They normally do not consume any of their own outputs. Specialisation and division of labour improves efficiency (more output from less resources). Greater dependence on others could make us more vulnerable as we do not have control over fulfilling our needs and wants. The extent of this vulnerability is greater if we are dependent on just a few people or organisations (e.g. large firms or Government entities).

Competition

Competition plays an enormous role in determining what is produced, who produces it, and who receives it. There is competition in both production and consumption. Producers compete to produce goods and services that are perceived to meet people’s needs and wants. They need to determine what to produce and how to produce it so that it meets its customers’ expectations but at a cost that will enable them to make profits. Increased competition makes this challenge more difficult for producers. They can compete on price, quality, or visibility; all of which puts pressure on profit margins.

Customers compete with each other to obtain goods or services. Customers compete to obtain the goods and services they believe will meet their needs and wants. Increased competition could result in people missing out or needing to pay a higher price to obtain what they want.

High competition between firms producing and selling goods and services is good for customers. They are likely to have a wider choice of goods and services and they are likely to be at a lower price. High competition between customers is good for firms producing and selling goods and services. Firms are more likely to find customers and are more likely to be able to sell their goods and services at a higher price.

For simplicity, we can describe competition for 4 scenarios.

• High competition between firms producing and selling goods and services and high competition between customers.
• High competition between firms producing and selling goods and services and low competition between customers.
• Low competition between firms producing and selling goods and services and low competition between customers.
• Low competition between firms producing and selling goods and services and high competition between customers.

High competition between firms producing and selling goods and services and high competition between customers

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High competition amongst both producers and customers is normally considered good for the economy and society as a whole. The strongest firms are most likely to thrive while some of the less competitive firms may still survive, as niche markets can be expected to form. The least competitive firms will fail but high demand will facilitate the entry of new firms (i.e. limited barriers to entry). Customers will have a wide variety of choice (in both quality and price).

If there is no intervention, high competition can be expected to remain. Firms will naturally adjust themselves to the changing needs of their customers. Some firms will grow bigger but renewed competition will restrict their growth and require them to remain nimble to changes. Smaller firms can also be expected to cooperate to negate any advantage size may offer. See my post Game Theory #6 - Triple Threat (Work-in-Progress) for a theoretical explanation. This is how most markets would naturally shape in a free market economy.

High competition between firms producing and selling goods and services and low competition between customers

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High competition amongst producers but low competition amongst customers is bad for most firms and good for the customers. The firms are at the mercy of the few customers. The customers may favour particular firms for reasons such as personal taste and price. They may favour the firms that are most adaptable at meeting their needs. It is unlikely all firms will be given opportunities to please these customers. Financially stronger firms have a better chance of being noticed and more likely to become favoured.

This scenario is unlikely to be sustainable for long as firms will be driven out of business or forced to focus on markets with more customers. This scenario will likely evolve into the scenario with low competition amongst both producers and customers.

Low competition between firms producing and selling goods and services and low competition between customers

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Low competition amongst both producers and customers could be beneficial to both but is likely to be bad for the economy and society as a whole. Lack of competition for the producers is likely to lead to lack of efficiency, lack of innovation, and higher prices (not necessarily bad for customers; see next paragraph). The customers are likely to be able to influence the focus of production as the producers do not not have a wide market. The extent of the customers influence could depend on the importance and necessity of the goods and services being offered and the availability of alternatives (e.g. close substitutes).

The lack of customers may give the impression that such markets are not important; therefore, shortcomings have little impact on the economy. However, the few customers could be the voice of many customers. Governments often spend on behalf of the people they supposedly represent. They are not spending for themselves but for others. Their priorities cannot be expected to align entirely with the people they are representing. Their demand might be based on political gain rather than product utility. Therefore, they will not hold the firm/s to the same standards as people who are spending on their own behalf.

Low competition between firms producing and selling goods and services and high competition between customers

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Low competition amongst producers and high competition amongst customers is one of the most common scenarios. This scenario can occur naturally. Natural barriers may exist because of high initial infrastructure or start-up costs. They could exist because of economies of scale that can only be realised from very large scale production. To reduce these barriers to entry may require existing and new firms to cooperate by sharing infrastructure and resources. Open source approaches to technology and ideas may also reduce research and development as a barrier to entry.

Some barriers to entry are imposed by Governments. These could be legal barriers such as patents, copyrights, or licensing. These could be regulations that are too costly for smaller firms to implement. These could be Government contracts to boost selected firms. Large firms existing in the industry are likely to want barriers to entry to reduce competition; thus, enabling them to remain profitable without the need to outperform their competition or the need to strongly adapt to their customers. Governments and large businesses often work together for mutual benefit; therefore, Governments have incentive to help keep these businesses remain big and profitable.

Summary of scenarios

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The table 1 briefly summarises the above four scenarios

Table 1: Competition Scenarios

Sellers	Buyers	Market Type	Barriers to Entry
Many	Many	MC & PC	None or Minimal
Few	Many	Oligopoly & Monopoly	Many and/or Strong
Many	Few	Oligopsony & Monopsony	Many and/or Strong
Few	Few	Crony Capitalism	Many and/or Strong

Note: MC is Monopolistic Competition and PC is Perfect Competition

When free markets alone are insufficient

Free markets are the solution to addressing most needs and wants through the provision of goods and services. However, they are not perfect. Some needs and wants will not be addressed through free markets. This is because catering for some needs and wants does not generate a profit. Free markets work well for goods and services that have clearly defined ownership and offer exclusivity (i.e. people who do not pay for it can be excluded from using it). Some needs and wants cannot be met with these types of goods and services. Good examples are our natural environmental needs and wants. Most people want clean fresh air. However, we cannot own clean fresh air nor exclude other people from enjoying it. Therefore, how we do we create a market for clean fresh air? The proposed response is likely to be Government intervention.

Governments can intervene by offering incentives to firms that reduce pollution or pollute under a particular limit. They could also intervene by charging or fining firms that do not meet certain targets or do not make certain changes to production. Intervention offers incentive and motivation for businesses to meet people’s needs and wants outside free market forces.

Government intervention could work well if the incentives and motivations could be balanced to sufficiently reduce pollution (should be considered an externality as it is a by-product of producing something) without negatively interrupting the free market operations of the primary goods and services produced. This is difficult to achieve as we are relying on estimates rather observed behaviour.

Decisions are made by Government with support from their team of “experts”; they often neglect alternative views or direct input from the people. Intervention often becomes over aggressive. This would favour larger firms and disadvantage smaller firms that may not be able to make the necessary changes demanded of them. It is also possible that firms will change their business model to profit from interventions as much as their core business. For example, Tesla are heavily subsidised by the Government for producing electric cars (Real Money).

Governments can be wrong about the causes of particular problems. They often act on incorrect or inconclusive information; thus, any intervention made by them makes matters worse. Governments have declared war on carbon (i.e. carbon dioxide). They treat carbon as the main cause of climate change. This is supported by their scientists and most scientists that are given mainstream attention. However, the impact of carbon on climate change is not completely settled. Many scientists that do not receive mainstream attention do not agree carbon is the main culprit and some even believe that the human impact on climate change is minimal.

There is also the debate around whether climate change is good or bad. Climate change effects most of the world. It is sometimes positive (e.g. produces high crop yields) and sometimes negative (e.g. increased drought in dry areas). The book ‘The Hockey Stick Illusion’, presents strong alternative arguments to conclusions presented by Government.

The illusion of failures of the market to justify Government intervention

Oligopolies and monopolies, in particular, are treated as examples of failures of the market to adequately meet people's needs and wants or as a flaw in capitalism. These types of market structures can occur because of natural barriers to entry. However, their growth is often assisted by Government actions. Governments intervene as a response to the manipulated perception of the flaws in capitalism. They might introduce taxes, subsidies, price floors, price ceilings, various regulations and laws, and sometimes even nationalise some industries. These interventions rarely significantly increase competition or improve efficiency.

Even if Government intervention is well informed and effective, it still needs to be funded. This funding normally comes from tax revenue. This could be direct taxes such as income or indirect taxes such as goods and services taxes. Funding could come from borrowing; this will need to be paid back eventually, which is likely to come from taxes.

Funding could come from money creation. If this is done responsibly (not excessively), it could reduce or prevent deflation (falling prices) without causing inflation. This is funding with no noticeable cost. It is using increased productivity and efficiency to fund expenditure. Otherwise, increased productivity results in lower costs and prices, which is likely to be deflationary. Excessive money creation will eventually lead to inflation. The lag could be long (e.g. several years). Therefore, inflation could be blamed on other reasons (e.g. Inflation blamed on Russia’s war on Ukraine instead of excessive money creation to fund Covid-19 policy).

My Thoughts

Free markets are the backbone of a healthy economy. They enable people to meet each other’s needs and wants with the provision of goods and services. However, they are not perfect and not all encompassing. Some needs and wants will not be met through free-market operations. These fallacies are used to justify Government intervention. Government intervention often results in more inefficiency and/or greater market failures. These market failures are often blamed on capitalism rather than market intervention. Hence, further invention is called for and applied.

The shortcomings of market operations are rarely met by intervention by Government. However, this also does not mean that weaknesses of free markets should simply be accepted. The gaps they leave should be filled. Community intervention could be preferred over Government intervention but the same problems could emerge if decision-making is centralised.

A decentralised community response could enable fair and appropriate decision-making that will address needs and wants not addressed by free-markets. Decentralisation can be achieved with the use of blockchains as decision making tools. Blockchains can fund initiatives using cryptocurrency and token creation. For a more in-depth discussion, read my post Blockchain Government – Part 2: Leadership from the Blockchain.

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