The Concise Guide To Economics
by Jim Cox
34. Perfect Competition
Perfect competition is the perverse theory modern economics has developed in dealing with firms, prices and resource allocation. Competition is normally, and correctly, understood to mean rivalry between firms in attracting consumer patronage. The theory of perfect competition reflects the influence that positivism and mathematics have had on economics.
In perfect competition, all firms produce the same identical goods, charge the same price for those goods, face a perfectly horizontal demand curve, experience no transaction costs, and buyers and sellers have perfect knowledge. Aside from the appalling lack of reality embodied in this theory--which should alone warrant its discard--the theory is also self-contradictory. A perfectly horizontal demand curve is self-contradictory on the very grounds of its propositions. A perfectly horizontal demand curve depicts ongoing sales at the same price, however to supply that increasing number of sales is to add to total supply, and an increase in total supply depresses prices! A perfectly elastic demand curve is therefore a theoretical impossibility.
Additionally, the theory of perfect competition is said to maximize consumer welfare as the marginal cost of production will equate exactly with the value the consumer places on that production as revealed by price. But in its quest to find competition in the large number of firms the consumer welfare-enhancing economies of large scale production are lost. Not many consumers will be delighted to know that the firm's marginal cost is equal to the price paid when that price is high due to the small scale production necessary to meet the conditions of perfect competition.
An example: Millions of auto producers might each produce ten cars per year at a marginal cost of $200,000. But with economies of large scale production forty auto companies may each produce 250,000 cars per year at a marginal cost of $15,000 while charging more than its marginal cost, say $20,000. It is undeniable that a consumer is better off buying the auto for the $20,000 than for the $200,000. As far as the consumer is concerned equating marginal costs and price is totally irrelevant; only economists pursuing mathematical tangents instead of human action would come to any other conclusion.
Given the assumption of perfect knowledge those looking at the world through "perfect competition colored glasses" have naturally condemned advertising--this condemnation is yet another perversity resulting from this theory.
Not only is perfect competition unrealistic but it is also undesirable since only an extremely limited variety of goods could even conceivably be produced under such conditions! Are there any other aspects of human life where one would set as a standard both an unrealistic and undesirable state of affairs?