The Theory of Perfect Competition Is Wholly Misleading

This article discusses the theory of perfect competition and argues that it is misleading. It explains how neoclassical economists define competition only in terms of price and ignore other forms of competition such as advertising and product differentiation. The article also criticizes the assumptions of perfect competition and argues that they do not accurately describe real-world markets.

Perfect Competition
The Theory of Perfect Competition Is Wholly Misleading
By Donald J. BoudreauxTUESDAY, NOVEMBER 27, 2018
ECONOMIC EDUCATION
If neoclassical economists are correct, economic competition reaches its apex — a state of
perfection — only when it ceases.
According to the supposed experts, competition is at its zenith when zero of it exists. It follows
that any activity that to a non-economist appears to be competitive is, in econ-speak, an instance
of “imperfect” or “monopolistic” competition. That activity isn’t competitive at all.
Has that automaker improved the styling of its mid-priced SUV? Does this motel chain advertise
and boast about the increased spaciousness of its guest rooms? Did that bakery introduce a new,
tastier mix of granola? When a non-economist witnesses such activities, she immediately
understands that these sellers are competing for buyers.
But when a neoclassical economist witnesses such activities, he detects nefariousness afoot. Any
seller that manages by means other than cutting prices to make its product more attractive to
consumers thereby escapes the necessity of cutting its prices as much as possible. Some degree
of competition might still exist insofar as this seller is restrained by market forces from raising its
price.
But to the extent that this seller successfully uses, not price cuts, but the likes of advertising,
branding, or product differentiation to persuade consumers to buy more of its output, this seller

has monopoly power. And use of this monopoly power distorts the allocation of resources by
causing that allocation to differ from what it would be in the absence of this monopoly power.
In this world, to build a better mousetrap is not to compete and to enrich but to monopolize and
to impoverish.
Consumers Care About More Than Prices
How can it be that economists’ conception of competition is so bizarre? The answer is that for
neoclassical economists’ competition is defined to operate only on prices. Successful attempts to
increase sales by doing anything other than cutting prices, therefore, are not only not
competitive, they are monopolistic because they decrease sellers’ need to cut prices.
Further, this competition isn’t perfect until all firms are under such intense pressure to keep
prices as low as possible that even the slightest price hike by an individual seller causes that
seller to lose all customers. This outcome is guaranteed by the assumed existence of such a
multitude of other firms selling the identical product that consumers who abandon the price-
hiking seller can effortlessly satisfy all of their demands for this product simply by switching
their patronage to the other sellers.
In a “perfectly competitive” market, sellers have no further need to cut prices. And because
competition is defined only as cutting prices, sellers also have no further scope to compete. The
only decision consistent with “competition” left for each seller to make is how much output to
sell at the prevailing market price.
Sellers, then, don’t actually compete in perfectly competitive markets. Instead, they merely react
to given market prices exclusively by adjusting the quantities they produce.

Not All Simplifying Assumptions Are Created Equal
Although economists have long recognized that the assumptions on which the theory of perfect
competition rests never actually describe reality, this theory nevertheless sets the standard
against which economists continue to assess the competitiveness of real-world markets. The
more closely real-world market structures and outcomes resemble those of a perfectly
competitive market, the more competitive do neoclassical economists judge real-world markets
to be.
These economists justify their use of the theory of perfect competition by correctly noting that no
theory accurately describes the reality that it is meant to explain. But in this case this justification
fails completely.
It’s true that all theories rest on simplifying assumptions. Yet when neoclassical economists
justify the unreality of the assumptions at the heart of the theory of perfect competition, they
reveal an apparent belief that simplifying assumptions are a sufficient condition for generating
useful theories.
Yet this belief is false. Assumptions are not justified merely because they are simplified. Instead,
simplifying assumptions are justified only if they result in theories that enhance our
understanding of phenomena that we seek to better understand.
Do the assumptions at the heart of the theory of perfect competition enable us to better
understand competition in reality? You decide. This theory assumes that
 the products available for sale have already been developed in all relevant details;

 firms never compete for customers by improving the quality or otherwise changing the
features of products they offer for sale;
 each firm in an industry produces outputs that are identical in consumers’ minds to those
produced by every other firm in that industry;
 such a very large number of firms exist that no firm has any control whatsoever over the
price it charges; each firm can sell as much as it wishes at the prevailing market price, but
if it charges any higher price, it makes no sales;
 both consumers and producers are fully informed about all relevant features of the
products and of the market, including knowledge of the most efficient means of
producing and distributing the outputs; and
 firms enter and leave each perfectly competitive industry instantaneously.
Except, perhaps, for the last of these assumptions, to use this set of assumptions is to assume
away the very phenomenon that the theory of perfection competition ostensibly is meant to
explain: competition.
In real-world markets, for a firm to compete means for that firm to strive in any peaceful manner
it likes to entice consumers to purchase more of its outputs. One way of so enticing consumers,
of course, is to cut prices. But cutting prices is hardly the only way, and it’s certainly not the way
that’s most creative. Other ways of competing include improving a product’s appearance,
performance, and durability.

Even better is to introduce an entirely new product. The most casual survey of reality reveals
these means of competing to be just as important to consumers as are cuts in prices. Yet in the
theory of perfect competition, these non-price means of competing are assumed away.
Also assumed away are advertising and other marketing efforts by sellers to better inform
consumers about available product offerings. After all, consumers who by assumption are fully
informed can learn nothing worthwhile from advertising or other means of marketing.
And to assume the existence of a multitude of producers each selling outputs identical to those of
other producers in their industry is to assume that entrepreneurs have already learned not only
that it is profitable to operate in whatever perfectly competitive industries they now operate, but
just how to operate profitably in those industries.
According to this theory, firms enter industries mechanically and instantaneously whenever the
prevailing market prices are sufficiently high to allow entrants to operate profitably. A firm
entering a perfectly competitive industry performs a feat that is no more competitive than that
which is performed by a pedestrian who, noticing a $20 bill on the sidewalk, bends down to pick
it up.
The Theory of Perfect Competition Is Wholly Misleading as a Guide to Real-World
Competition
If the above disquisition reads too much like inside baseball (or inside academic economics), it is
warranted by the recent rise in the number of calls for more active antitrust enforcement. Very
many such calls refer, explicitly or implicitly, to the theory of perfect competition. These calls
treat this theory as if it supplies an unquestioned, and unquestionably sound, standard against
which to judge real-world markets.

But in fact the theory of perfect competition should be utterly rejected, both as a theory of
competition (which it is not) and as offering an appropriate standard against which to judge real-
world markets (which it does not).
Monopoly
Andrew Coyne: Canada Post can't deliver, yet Liberals insist on upholding its monopoly
Mail consumers should not have to pay to curb Canada Post’s losses, any more than Canada
Post, or the taxpayer, should be forced to underwrite mail consumers.
You have to hand it to the Liberals. No, really, you have to, because if you don’t they’ll take it
anyway. Though not before solemnly assuring you they just need to borrow it for the weekend
and can have it back to you Monday at the latest.
In the latest rewrite of a key promise from their 2015 election platform (entitled, if memory
serves, “Never Give A Sucker An Even Break”), the Liberals have announced they will not, after
all, restore home mail delivery to those now forced to use the hated “community mailboxes,” a
money-saving initiative of the late Conservative government.
True, those who still have home delivery will not have it taken away — honest — but neither
will those who have already had it taken away get it back. In other words, the status quo, ex-
Harper. “We decided to adopt a forward-looking vision for Canada Post,” Public Services
Minister Carla Qualtrough explained. “We’re not going to put the toothpaste back in the tube.”
Hear that, Liberal voters? It’s time to look forward, and not backward to, say, October of 2015.
Because, those who do might recall, toothpaste-backputting was pretty much what the Liberals
ran on. Remember? “We will save home mail delivery,” the platform promised, in bold letters.

“We will stop Stephen Harper’s plan to end door-to-door mail delivery in Canada and undertake
a new review of Canada Post to make sure that it provides high-quality service at a reasonable
price to Canadians, no matter where they live.”
Now, it is true that when the Liberals promised “high-quality service at a reasonable price,” they
did not actually promise Canadians, no matter where they live, that their service would improve
at all. By “high-quality service” they might conceivably have meant “precisely the same rotten
service you are getting now.”
Likewise, when they promised a “new review of Canada Post,” did they explicitly rule out the
possibility that the new review would result, two years later, in the old policy? No, they did not.
So no, the Liberals did not promise, in so many words, to restore mail delivery to every home
across the land. They just weren’t overly concerned if people thought they did.
But never mind. Maybe the old pseudo-promise was irresponsible. Maybe the Liberals are right
to sort-of break it. Maybe the new semi-policy — neither expanding the use of community
mailboxes nor abolishing them where they now exist, a sort of Missouri Compromise of the mail
— is just the kind of non-change the country needs.
After all, as it is commonly presented, the issue presents governments with a difficult choice,
between the responsibility to provide employment for Canada Post workers — er, to provide
mail service to all Canadians — and the responsibility to avoid the kind of massive losses such a
commitment implies. There is, we are told, a balance to be struck.
There is, if you accept the underlying premise: that only Canada Post can deliver the mail; that
the mail can only be delivered at the same cost, on the same terms, and with the same strike-
happy workforce and bone-stupid management as Canada Post employs. This is not true, as a

matter of observable fact: private couriers will deliver to any address in Canada, where they are
allowed to do so, as with packages. It is true only as a matter of statute: by law, Canada Post is
granted the “exclusive privilege” — monopoly — over all letter mail to or from any point in the
country. Private carriers are permitted to deliver letters “of an urgent nature,” but only if they
charge at least three times the prevailing rate of postage.
This may seem irrelevant, at a time when so many have abandoned conventional letter mail for
electronic communications. But part of the reason “snail mail” fell into such disrepute is the cost
and delays involved in sending a letter via Canada Post. The six-fold increase in the price of a
stamp since 1981; the end of first weekend then overnight delivery; the semi-annual strikes: long
before community mailboxes, Canada Post was delivering the mail less often to fewer addresses
less reliably at greater expense, year after year after year. That’s what monopolies do.
If we were setting up a post office today, presumably we would not grant it a statutory
monopoly. Why do we still have one, in 2018? The usual reason is the “universal mandate,” the
corresponding obligation of Canada Post to deliver every letter to every domestic address for the
same price. Without a monopoly, it is claimed, competitors would “cream off” low-cost urban
routes, while abandoning high-cost rural delivery. In time, so would the post office.
Leave aside the inconvenient fact that Canada Post does not deliver to rural addresses now.
Focus, rather, on that seeming throwaway line: “for the same price.” Why should it cost the
same, by law, to deliver a letter, whether it is delivered across town or across the country? We
don’t insist on this bizarre principle when it comes to the telephone, or air travel, or anything
else, really. So why do we, when it comes to the post office?

Answer: because it serves as an argument for preserving the monopoly. It isn’t uniform pricing
that requires the monopoly. It’s the monopoly that requires uniform pricing. Abolish the latter,
let the price of a stamp reflect the cost of delivery, and whatever case there may be for the former
dissolves.
People in rural areas who want the mail delivered to their door might have to pay more for it (or
might not: Canada Post is hardly the benchmark of efficiency), but at least they could get it
delivered. Whereas now they cannot get it at any price — again, not by circumstance but by law.
We are in the absurd position of enforcing a monopoly on a service Canada Post refuses to
deliver.
The notion that there is a “balance” to be struck, in short, is nonsense. Ending all home mail
delivery is not a matter of being “realistic,” a regrettable but necessary measure to save Canada
Post from bankruptcy. Neither is ordering Canada Post to deliver to every address, no matter the
cost, a brave defence of public service in the face of neoliberal bean-counters. Both, rather, are
simple extensions of the logic of monopoly: simple, and unnecessary.
Mail consumers should not have to pay to curb Canada Post’s losses, any more than Canada
Post, or the taxpayer, should be forced to underwrite mail consumers. Open the mail to
competition, rather, and set both consumers and taxpayers free.
Monopolistic Competition
How Starbucks Plans To Roast Its Coffeehouse Competition
Anderia Cheng

On a recent Sunday evening at Starbucks’ new Reserve Roastery in New York’s swanky
Meatpacking District, throngs of customers packed the 23,000-square-foot three-story emporium,
where specialty coffee, pizza and pastries to be served in-house had all been roasted or baked on
site and a cocktail bar on the top floor served coffee-infused alcohol.
At the center of the store, a barista in the location’s signature newsboy-style gray shirt and khaki
pants served up special-batch Costa Rica coffee samples after a siphon coffee demo and talked
about how she, a six-year Starbucks employee, had applied to work at the location and gone
through a three-month training on coffee before the store opened. Meanwhile, as a customer self-
described as a coffee connoisseur sampled the siphon brew, he expressed satisfaction with how it
had delivered on its artisanal promise.
“Loved the whole experience!!” a customer named Sajal B. said in a recent Yelp review. “It's
like a coffee museum.”
As Starbucks is faced with more competition than ever, from McDonald’s McCafe on the low
end to Blue Bottle Coffee on the upscale end, the new Reserve Roastery in New York is one way
the Seattle-based coffeehouse giant is looking to keep its coffee cachet and keep its customers
frequenting its nearly 30,000 regular locations globally. That’s not to mention that in China, its
fastest-growing market and second-largest after the U.S., the company is contending with what
president and CEO Kevin Johnson described as “highly promotional and
disruptive” competition.
As part of its plan to stay at the top, Starbucks is working with Uber Eats to deliver coffee to
cities including Miami and San Francisco, with a goal of delivering from nearly a quarter of its

more than 8,000 U.S. company-operated locations by the spring. In China, Starbucks has worked
with Alibaba to deliver from more than 2,000 stores, a number that it said will continue to grow.
As part of the industrywide push to use tech and other tools to free employees from tasks so they
can spend more time with customers, Starbucks said it has moved some cleaning tasks to after
hours and is automating product planning and replenishment to reduce clutter. The company is
also working with Microsoft to cloud-connect its coffee and other machines to track demand and
beverage consistency.
Not surprisingly, Starbucks is on board the data science bandwagon and is studying consumer
preferences to better personalize and introduce offerings. For instance, it said it unveiled a
limited-edition red cup promotion during the holidays in response to popular demand. It’s also
expanding its draft Nitro cold brew to all of its U.S. company-owned locations by the end of
fiscal 2019, from about 40% currently.
These and other efforts have paid off. The company’s shares rose 4% on Friday to a near-record
high after it reported better-than-expected fiscal first-quarter profit and sales late Thursday and
said the number of its U.S. Starbucks Rewards active customers jumped 14%, to 16.3 million, in
the quarter that ended Dec. 30. Global comparable store sales increased 4%, led by a 3% increase
in average transaction amount. Same-store sales rose 4% in the U.S. and 1% in China even
though transactions, an indicator of traffic, declined 2% there.
“The company is producing very respectable same-store sales growth and still offers unit growth
despite approaching 30,000 worldwide stores,” John Zolidis, president of Quo Vadis Capital,
said in a report Friday. “We are in the very early days of seeing the benefit from delivery. …
Starbucks is ahead of the competition with its loyalty program and app. … It drives convenience

and means that a platform is already in place for driving adoption of delivery, among other
promotional efforts.”
Starbucks’ growing crop of competition also looks to have a ways to go to catch up, at least
when it comes to market share. The company’s U.S. share in the specialty coffeehouse market
jumped to 66.7% in 2017, from 58.8% in 2012, according to Euromonitor. The No. 2 in the U.S.
space, Caribou Coffee, saw its share dip to 1.5%, from 1.6%, during the same time.
Globally, Starbucks’ share in the space rose to 46.1%, from 39.4%, over that time while No. 2
McDonald’s McCafe’s share stood flat at 3.1%, Euromonitor data shows.
Last year, Starbucks licensed its global packaged coffee business to rival Nestle to distribute its
coffee to supermarkets and restaurants worldwide. The company said late Thursday that
Starbucks coffee will be rolled out on Nestle’s Nespresso and Dolce Gusto machine platforms
beginning this spring.
“The strategy is working,” Johnson said on a conference call Thursday night. “We remain
confident in the longer-term outlook for the business.”
Even as rivals nip at its heels, with global middle-class consumers increasingly on a coffee kick,
it looks like Starbucks will have the wind at its back.
Oligopoly
Damning report finds banking industry an 'oligopoly' that exploits its customers
Productivity Commission says banking system so concentrated it can boost profits without
repercussions

Australia’s banking system has become so concentrated its major banks can pass on costs and set
prices to boost profits without fear of losing market share, through every stage of the economic
cycle, the Productivity Commission has found.
The “four pillars” policy, which has underpinned Australia’s banking system since the 1990s,
and which was designed to prevent mergers between the four biggest banks to maintain
competition, has likely contributed to the problem, with evidence showing it is now preventing
competition.
The reality of Australia’s “oligopolistic banking system” means the biggest banks are now
regularly exploiting the inertia of existing customers, maintaining their market position with
persistently opaque pricing, conflicted advice and remuneration arrangements, and a lack of
easily accessible information that induces their customers to maintain loyalty to unsuitable
products.
They are also overwhelming the population with a proliferation of thousands of similar financial
products that are impossible to sift through.
Those are some of the damning conclusions in a report on the competitiveness of the financial
system by the Productivity Commission (PC), released on Friday.
The treasurer, Scott Morrison, has welcomed the report, saying he will consider which
recommendations to adopt after consulting widely, and after the banking royal commission has
wrapped up.
Morrison said the banking system was unquestionably strong but some regulations had not
necessarily made customers stronger.

“Too often we have also become willing participants in a game where the deck is stacked against
us,” he said on Friday. “Because you can almost guarantee it, the more passive a customer is, the
worse deal they are going to get.
“Real market power needs to be put back in the hands of the customer ... and we the customers
have a role to play in this. Customers must stop being passengers and bystanders in their own
cause.”
In a speech on Friday, Morrison said from July next year banks would have to start sharing more
information on credit and debit cards, and deposit and transaction accounts, so customers could
make better-informed choices.
“Open banking will be a game-changer,” he said. “Granting third-party access to your data
securely will also make the process of switching between banks less painful and help overcome
the ‘hassle factor’. More choice, more competition and importantly, more power.”
However, he has already rejected a key recommendation from the report that the Australian
Competition and Consumer Commission (ACCC) become a formal “competition champion” that
stress tests the competitive implications of proposed regulatory changes before they are
implemented.
It said the ACCC, as competition champion, should become a permanent member of the Council
of Financial Regulators so it can be in regular formal discussions with the Reserve Bank, the
Australian Prudential Regulation Authority, and the Australian Securities and Investment
Commission.
However, Morrison has rejected that recommendation.

The report also found the major banks benefit from a “too big to fail” status and an expectation
of government intervention if one or more of these banks were in financial difficulties.
This status lowers the cost of funds for these banks and means larger banks benefit from lower
costs of funding, compared with smaller institutions.
The Productivity Commission recommended the ACCC undertake studies on the effect of
vertical and horizontal integration on competition in the financial system every five years. The
first of these studies should begin in 2019
It has also called for the fine tuning of Apra’s prudential measures to address the imbalance in
lending between businesses and the home mortgage market.