Market Preview: Defining Competition

US - Weekly US Market Preview provided by Steve R. Meyer, Ph.D., Paragon Economics, Inc.
calendar icon 17 February 2010
clock icon 5 minute read

You are going to be hearing a lot about “competition“ in coming months. I mentioned in last week’s column the upcoming series of USDA/DOJ (Department of Justice) workshops that commence in just under a month with a meeting on March 12 in Ankeny, Iowa, that will address crops, seed and hog/pork topics. Competition or the lack thereof will be a constant storyline this year. A schedule of all workshops can be found here.

But what is competition? Would we know it if we see it or realise it is missing when it is gone? Low farm prices are not necessarily an indication of a low level of competition, even though they can be. High input prices (or high prices of products made from farm outputs) do not necessarily mean that competition is non-existent or insufficient. Even the presence of large firms does not necessarily mean that competition is absent in the marketplace, though their existence does move us away from a purely or perfectly competitive model toward some market structure where competitive outcomes are still quite possible but are not guaranteed.

In 1964, Justice Potter Stewart tried to explain “hard-core“ pornography with his now-famous comment: “I shall not, today, attempt further to define the kinds of material I understand to be embraced... but I know it when I see it...“

We need and have more to go on as we deal with issues of competition. My former professor, Richard Leftwich, explains competition by writing: “The term competition is used ambiguously, not only in ordinary conversation, but in economic literature as well. Its common meaning is ‘rivalry,’ but in economics, when used along with the word(s) ‘pure’ or ‘perfect,’ it carries a different meaning.“

The terms “pure“ or “perfect“ competition imply certain assumptions about the firms or agents involved in a market and, for the most part, represent a theoretical norm that has seldom been achieved.

The necessary conditions for pure competition are:

  • Homogeneity of product as perceived by buyers. Agriculture once fit this condition well. No. 2 yellow corn is (or was) No. 2 yellow corn. No. 1 hard, red winter wheat is (or was) No. 1 hard, red winter wheat. Hogs were hogs. It does not matter who a buyer buys from, the product is the same.

  • Smallness of each buyer and seller relative to the market. One more or one fewer seller does not affect total supply. One more or less buyer does not affect total demand much.

  • Absence of artificial restraints. That is, there are no “outside“ restraints on supply, demand or prices. There must be no government or institutional fixing or restraining of supplies or prices.

  • Mobility. Goods, services and resources must be free to move in the economy. Firms must be free to enter or exit the industry in question and other industries. Resources (capital and labor) must be free to move to uses where they desire employment.

To these five conditions for pure competition, another is added to describe “perfect competition:“

  • All economic units possess complete knowledge of the economy. All prices are known immediately, thus allowing buyers to buy at the lowest price and sellers to sell to the highest bidder. This action will result in one price in a perfectly competitive market and any adjustments will be instantaneous.

A Hog is No Longer Just a Hog

It is obvious that, even if hog and pork markets may once have had several of these characteristics, they no longer do. Hogs and pork products, while still similar, are differentiated in many ways. There have always been relatively few buyers and now there are, for all intents, relatively few sellers of hogs and some sellers do make a difference for total supply. There are still very few “artificial“ restraints in the hog and pork business even though some “externalities,“ such as environmental costs and regulations, are now material barriers to entry and resource mobility. And, finally, no one possesses complete knowledge and, perhaps more important, the knowledge levels of market participants are not equal. Some know more than others about supplies, demands, etc., and can thus capitalize on that knowledge position. And it is not just packers who enjoy the superior position.

So what good does this model provide? Leftwich offers three:

First, pure or perfect competition represents a logical starting point to study markets. Just as physicists begin with the assumption of no friction when they obviously know that friction is part of the physical world, economists start with some “friction-free“ assumptions and then relax them to add realism.

Second, competition does exist to a large degree in our economy. While there aren’t “many“ grocery stores and they are far from “small“ these days, they still compete for consumers’ dollars. While there are only 70,000 or so hog producers instead of the 2.1 million in 1949, they still compete to earn a profit.

Third, and perhaps most important, the pure or perfect competition model serves as a “norm“ against which the actual performance of markets can be compared.

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