Competition and Efficiency

Abstract

The association between economic efficiency and competition goes back at least as far as Adam Smith’s ‘invisible hand’ metaphor. Indeed, a goodly portion of the vast body of subsequent work in value theory has dealt with the normative issues arising from the workings of the competitive economy. Thus any short essay on the topic must be somewhat idiosyncratic, focusing upon the points which are of greatest interest to the author. Therefore, I shall limit my attention to the properties of the (static, partial equilibrium) economic model of perfect competition and how its use has recently been extended to add to our understanding of a larger range of real world markets. I must leave to others the tasks of sorting out the importance of competition in, for example, the Schumpeterian process of ‘creative destruction’, the aggregation and transmission of society’s stock of information, or the evolutionary progress of technological advance. Fortunately for my purposes, the historical development of the competitive model has been thoroughly analysed by Stigler (1957). The formulation of the model, as we know it today, was completed in the work of Knight (1921). It is interesting to note that the last refinement to be added was the free mobility of resources across industries: i.e. the entry and exist of firms. In his insightful concluding section, Stigler points out that competition can flourish within a market without this last ingredient. (Consider an agricultural market with Ricardian rents.) He suggested that the term ‘market competition’ be used to describe such situations, and that the term ‘industrial competition’ be applied when mobility across industries is present. The work that I shall discuss deals with the converse possibility: perfectly contestable markets, situations in which competition may not necessarily exist within a particular market, but firms (and resources) are assumed to be perfectly mobile across industries.