This essay originally appeared in Ayn Rand’s The Objectivist, vol. 7, nos. 8 and 9, August and September, 1968. It was posted on May 23, 2006, not May 18.
The doctrine of “pure and perfect competition” marks the almost total severance of economic thought from reality. It is the dead end of the attempt to defend capitalism on a collectivist base.
Ironically, that attempt took hold in economics in the late nineteenth century (and has been gaining influence ever since) through the efforts of Victorian economists to refute the theories of Karl Marx on the subject of value and price. The rationing theory of prices was advanced as the alternative to the Marxian labor theory of value. The irony is that the “pure and perfect competition” doctrine is to the left of Marxism.
Marxism denounced capitalism merely for the existence of profits. The “pure and perfect competition” doctrine denounces capitalism because businessmen refuse to suffer losses. The argument of the supporters of “pure and perfect competition” is not that businessmen make excessive profits through any kind of “monopoly,” but that they are “monopolistic” in refusing to sell their products at a loss—which businessmen would have to do if they treated their plant and equipment as costless natural resources that acquired value only when they happened to be “scarce.”
The “pure and perfect competition” doctrine distorts the facts of reality to a greater extent than did the traditional critiques of capitalism. Those critiques recognized that competition is a fundamental element of capitalism, but they denounced it.
Capitalism, they claimed, is ruled by the “law of the jungle,” by the principles of “dog eat dog” and “the survival of the fittest.” The “pure and perfect competition” doctrine proceeds from the same base as these earlier critiques, and is in full agreement with them in their objections to such characteristics of the process of competition as the continuous improvement in products, the variety of products, advertising, and the existence of idle capacity. Both schools regard all these characteristics of competition as a “waste” of “society’s scarce resources.”
But the “pure and perfect competition” doctrine regards these characteristics as “imperfections” and attacks capitalism on the grounds that capitalism lacks competition.
Every industry, it asserts, is “imperfectly competitive” (with the barely possible exception of wheat farming). Every industry is guilty of “monopolistic competition” or “oligopoly.” In the words of Professor Bach:
“There is a spectrum from pure competition to pure monopoly. Where there are a good many sellers of only slightly differentiated products, but not enough to make the market perfectly competitive, we call the situation ‘monopolistic competition.’” And: “Where there are only a few competing producers so each producer must take into account what each other producer does, we call the situation ‘oligopoly,’ which means few sellers.” (George Leland Bach, Economics: An Introduction to Analysis and Policy, 6th ed., Prentice-Hall, Inc., Englewood Cliffs, New Jersey, 1968, p. 337. Bach expresses the same view in the eleventh edition of his book, published in 1987, pp. 376–377, but not as succinctly.)
The concepts of “monopolistic competition” and “oligopoly” are indistinguishable, both in theory and in practice. As examples of “monopolistic competition,” Professor Bach cites Kellogg and Post in the field of breakfast cereals, and RCA and Philco in the field of television sets—even though these industries are fully as “oligopolistic” as the automobile or steel industry. (Even small retail establishments, a more popular example of “monopolistic competition,” can also be classified under “oligopoly,” since there are only a few of a given kind in a given neighborhood.) In any case, these two concepts embrace virtually all industries, except the few that are called “pure monopoly.”
The competition that capitalism is accused of lacking—as a result of “monopolistic competition” and “oligopoly”—is called price competition.
The nature of price competition, as contemporary economists see it, is indicated in another passage in Professor Bach’s textbook:
“Analytically, the crucial thing about an oligopoly is the small number of sellers, which makes it imperative for each to weigh carefully the reactions of the others to his own price, production, and sales policies. The result is a strong pressure to collude to avoid price competition or to avoid it without formal collusion.” (Ibid., p. 361.)
Capitalism is accused of lacking price competition on the following grounds: if there are few sellers in a market, any seller who cuts his price must take into account the fact that the other sellers will match his cut—so he may be better off if he refrains from price cutting; thus prices will not be driven down to the level of “marginal cost” or to the point where they “ration” the benefit of “scarce” capacity.
Consider the evasion entailed in the accusation that capitalism lacks price competition. Every decade, since the beginning of the Industrial Revolution, commodities have become not only better, but also cheaper—if not always in terms of paper money (the value of which has been constantly reduced by the policies of governments), then in terms of the labor and effort that must be expended to earn them. What is it that has made producers lower their prices for the last two hundred years? Blankout.
Actual price competition is an omnipresent phenomenon in a capitalist economy. But it is completely unlike the kind of pricing envisioned by the doctrine of “pure and perfect competition.” It is not the product of a mass of short-sighted, individually insignificant little chiselers, each of whom acts to cut his price in the hope that his action won’t be noticed by any of the others. The real-life competitor who cuts his price does not live in a rat’s world, hoping to scurry away undetected with a morsel of the cheese of thousands of other rats, only to find that they too have been guided by the same stupidity, with the result that all have less cheese.
The competitor who cuts his price is fully aware of the impact on other competitors and that they will try to match his price. He acts in the knowledge that some of them will not be able to afford the cut, while he is, and that he will eventually pick up their business, as well as a major portion of any additional business that may come to the industry as a whole as the result of charging a lower price. He is able to afford the cut when and if his productive efficiency is greater than theirs, which lowers his costs to a level they cannot match.
The ability to lower the costs of production is the base of price competition. It enables an efficient producer who lowers his prices, to gain most of the new customers in his field; his lower costs become the source of additional profits, the reinvestment of which enables him to expand his capacity. Furthermore, his cost-cutting ability permits him to forestall the potential competition of outsiders who might be tempted to enter his field, drawn by the hope of making profits at high prices, but who cannot match his cost efficiency and, consequently, his lower prices. Thus price competition, under capitalism, is the result of a contest of efficiency, competence, ability.
Price competition is not the self-sacrificial chiseling of prices to “marginal cost” or their day by day, minute by minute adjustment to the requirements of “rationing scarce capacity.” It is the setting of prices perhaps only once a year—by the most efficient, lowest-cost producers, motivated by their own self-interest. The extent of the price competition varies in direct proportion to the size and the economic potency of these producers. It is firms like Ford, General Motors and A & P—not a microscopic-sized wheat farmer or sharecropper—that are responsible for price competition. The price competition of the giant Ford Motor Company reduced the price of automobiles from a level at which they could be only rich men’s toys to a level at which a low-paid laborer could afford to own a car. The price competition of General Motors was so intense that firms like Kaiser and Studebaker could not meet it. The price competition of A & P was so successful that the supporters of “pure and perfect competition” have never stopped complaining about all the two-by-four grocery stores that had to go out of business.
Competition is the means by which continuous progress and improvement are brought about. And nothing could be more pure and perfect—in the rational sense of these terms—than the competition which takes place under capitalism.
The ideal of the “pure and perfect competition” doctrine, however, is a totally stagnant economy—the “static state,” as it is called—in which production and consumption consist of an endless repetition of the same motions. (For a valuable discussion of the influence of this “ideal” on contemporary economics, see von Mises, Human Action.)
It is in the name of this “ideal” that the supporters of “pure and perfect competition” attack the constant introduction of new or improved products, the evergrowing variety of products, and the advertising required to keep people abreast of what is being offered.
And only from the standpoint of this “ideal” can one declare that idle capacity is a “waste”—for only in a “static state” would there be no need for any unused capacity.
A capitalist economy is not “static.” Producers know that they must respond to changes in conditions. They endeavor always to have a margin of idle capacity, which can be brought into production if and when it is needed. Under capitalism, the normal state of production requires the possession of extra machines and tools in every industry, to meet every foreseeable change in demand. This is not a “waste,” not any more than the fact that consumers under capitalism own more shirts than the ones they happen to be wearing.
What the “pure and perfect competition” doctrine seeks is the abolition of competition among producers. Its “ideal” is a state in which no producer is able to take any business away from another producer. If a man is producing at full capacity, he cannot meet the demand of a single additional buyer, let alone compete for that demand. And if he is not producing at full capacity and is charging a price equal to his “marginal cost,” he still cannot compete for the demand of any additional buyers because he is forbidden to “differentiate” his product or to advertise it.
The “pure and perfect competition” doctrine seeks to replace the competition among producers in the creation of wealth, with a competition among consumers in the form of a mad scramble for a fixed stock of existing wealth. It seeks a state of affairs in which no additional buyer can obtain a product without depriving some other buyer of the goods he wants—for that is what competition at full capacity would mean. It seeks to make men competitors in consumption rather than in production. It seeks to transform the competition of human beings into a competition of animals fighting over a static quantity of prey. In other words, when it denounces capitalism, it is denouncing the fact that capitalism is not ruled by the law of the jungle.
The supporters of “pure and perfect competition” are aware of the fact that their doctrine is inapplicable to reality. This does not trouble them. Their view is expressed by Professor Wilcox, who observes casually (in a passage immediately following his alleged definition—the list of conditions I quoted earlier):
“Perfect competition, thus defined, probably does not exist, never has existed, and never can exist. . . . Actual competition always departs, to a greater or lesser degree, from the ideal of perfection. Perfect competition is thus a mere concept, a standard by which to measure the varying degrees of imperfection that characterize the actual markets in which goods are bought and sold.”
This “concept” divorced from reality, this Platonic “ideal of perfection” drawn from non-existence to serve as the “standard” for judging existence, is one of the principal reasons why businessmen have been imprisoned, major corporations broken up and others prevented from expanding, and why economic progress has been retarded and the improvement of man’s material well-being significantly undercut. This “concept” is at the base of antitrust prosecutions, which have forced businessmen to operate under conditions approaching a reign of terror.
Such are the effects of mysticism when it is brought into economics. Non-existence has no consequences; but those who advocate it, do.
George Reisman, Ph.D., is Pepperdine University Professor Emeritus of Economics and is the author of Capitalism: A Treatise on Economics (Ottawa, Illinois: Jameson Books, 1996). His web site is http://www.capitalism.net/. This essay is available as a pamphlet from The Jefferson School of Philosophy, Economics, and Psychology. The author wishes to note that his book Capitalism contains a far more comprehensive and detailed treatment of the subjects dealt with here (see in particular, pp. 425-437). Where possible, references have been updated to conform with those in Capitalism.
Copyright © 1968 by The Objectivist; Copyright © 1991, 2005 by George Reisman. Provided that credit is given to the author and he is notified by e-mail, permission is hereby granted to post this essay on the internet and otherwise noncommercially distribute it electronically or in print, other than as part of a book. All other rights reserved.
