Competition

I. Introduction

Today the coach was fired because the team is no longer competitive. The problem is that the candidate is no longer competitive in that district. The competition was intense for the last remaining tickets to the show. The race was very competitive, and the fastest runner won.

This class we will discuss competition, a term that is familiar to all of you. It is one of the most important terms in all of economics and business. It used to be a big part of school, but has been de-emphasized in the last ten years. Competition still is important in sports.

Competition has the same meaning in economics as in everyday activities: competition is when several people try to attain the same goal. It could be winning a race or selling a good or service to a potential customer.

Free enterprise is based on competition bringing out the best in business and the lowest prices for consumers. If a price is too high or a business too inefficient, then competition is what brings a competitor along to do better.

Opponents of competition say it is wasteful to have multiple people or companies produce the same thing. Or they do not like the way that competition causes someone to lose. Many parents oppose competition in school, because for every winner there is a loser, and that might be their child. Actually, in difficult competitions there can be dozens of losers for every winner. Tournaments, for example, have one winner but many losers.

However, the same people who oppose competition in business or school can be found watching professional sporting events like the Super Bowl, or entertainment competitions like American Idol. If they are having a medical operation, wouldn’t they want the doctor who had the best grades and track record? Or if they are flying on an airplane, wouldn’t they want the pilot who did the best in flight school and on the job? If competition there is acceptable, then why not in business and school also?

Competition, in fact, yields enormous benefits for the losers as well as the winners. Competition is a great motivator. It is also an essential part of the invisible hand that channels work and supplies towards their most useful purposes. Competition increases efficiency. Competition encourages innovation. It allows to people to do what was thought to be impossible. Whenever we are beaten by a competitor, and all of us experience that many times, we are left to ask ourselves why our competitor was better than we were. Next time, we can do better.

The U.S. Constitution itself can be understood as system using competition for power to prevent anyone from becoming too powerful. It established three separate branches of government to serve as checks and balances on each other. No individual or branch can grab too much power because the system protects and promotes competition.

The system of political competition has worked well. When Chief Justice John Marshall expanded Supreme Court power so much that it invalidated a Georgia law applying to Indian land, President Andrew Jackson refused to enforce the Court’s ruling. A century later President Truman ordered a government takeover of the steel mills, and the Supreme Court asserted its power and blocked him. The competition for power prevents any branch from growing too strong.

Competition in sports drives participants to their very best. No professional football team has ever won three Super Bowls in a row. Why? Because once a team wins the top prize, then all the other teams worker harder to beat it. The other teams become better due to the strong incentive of competition.

In 1968, an obscure high-jumper named Dick Fosbury was the object of ridicule because he invented a completely different way of jumping over the bar. Everyone else used the obvious way, whereby the jumper runs and kicks one foot up in order to clear and roll over the bar face down. But Fosbury would run up to bar, twist around and then try to glide over the bar headfirst with his back facing downwards, and his face towards the sky. They called his technique the Fosbury Flop. It was a bit of a joke until he stunned the sports world by winning the Olympic gold medal in 1968. Rather than lose, everyone started imitating him and the world record advanced at the double its prior rate. The world record using his technique has skyrocketed to about 8 feet high for men and nearly 7 feet high for women.

The benefits of competition extend even to political campaigns. The presidential race in America is increasingly competitive. So competitive, in fact, that no presidential candidate has won even 50% of the vote in 16 years. Experts predict that neither Bush nor Kerry will attract 50% of the vote in November either. The intense competition tends to keep the power in the hands of the people. A dictator who does not have to face reelection has far more power than an American president does, thanks to this political competition in America.

Competition is also a great way to motivate yourself. Virtually no one likes to work or study. But people dislike losing even more. Look around at achievements by others and then ask yourself: why not me? Sometimes, the achievers are those who overcome the greatest obstacles. At my local grocery store, the fastest checkout clerk has only one good arm. Yet he is more efficient than all the other clerks who have two good arms. Frequently the best athlete is the one with less God-given skills than others. Rather, the best athlete is often the one who tries the hardest, both in practice and in the game. The same is often true for the best student and the best business.

In business, the major beneficiaries of competition are the most efficient companies and the consumers. The more competition by grocery stores in town, for example, the lower their prices are likely to be for the consumer. The most efficient grocery store (including considerations like location) will likely be the most profitable and the one that lasts the longest. Businesses know that they have to work hard to beat their competition. Without that competition, it would be very unpleasant for us to shop for goods and services. Communist countries have little competition and many unsatisfied consumers.

Businesses themselves, however, often dislike competition because it can reduce their ability to earn profits. To protect consumers, federal laws limit the ability of businesses to reduce competition.

II. Perfect Competition

Perfect competition is an ideal that rarely exists in practice. But the more competitive the market, the better it is for consumers, so it is useful to consider the conditions for perfect competition:

  1. Goods that are perfect substitutes for each other must be provided by different companies. Pencils are a good example, because it is a standard good. One brand of pencil substitutes easily for another. Any variance in quality would prevent perfect substitution, and perfect competition.
  1. There needs to be enough companies making the same good to ensure that is enough real competition. Two or even five students competing for a good grade may not be enough. They may all work less in the expectation that others are working less also. In a large group of students, however, you can be sure that someone is working hard. Likewise, two gas stations on a street corner may not be enough to establish perfect competition. They can watch each other’s prices and both may raise them. But five or so independent gas stations in an area would be competitive.
  1. The competitors must have identical costs for their supplies. If one competitor, say a gas station, has much higher costs than the others, then it is not going to add much to the competition. Conversely, if a gas station were sitting on top of an oil well, then it may not ensure perfect competition either. It may reap enormous profits at the expense of the consumer, or it may first drive the other gas stations out of business and then raise prices for its gas even higher than what the other stations had been selling it at.
  1. Fully informed consumers and suppliers are also necessary for perfect competition. If Wendy’s tried to sell a healthy burger but few knew about it, then its competition with greasy burgers by McDonald’s or Burger King is not going to be perfect.

III. Costs

It can be difficult running a business. Your costs will seem to be always rising. If you are profitable, then you can expect competitors to move into your turf and drive your revenue down.

Why are your costs rising? Three reasons:

  1. In the short run, you have diminishing marginal productivity. Additional employees are not likely to be as productive as your first employees, for example.
  2. In the long run, you may have decreasing returns to scale. The bigger you become, the more difficult it is to manage everything and everyone. Waste can get out of hand.
  3. In the long run, your industry may also see rising prices for the inputs. Your suppliers increase their prices periodically. Scarce resources may become even scarcer.

Experienced business managers will tell you that profitability is made by reducing expenses. This has certainly been true for Wal-Mart. It is constantly driving costs down with its suppliers. Now it even demands that suppliers guarantee certain profit levels for Wal-Mart itself. It has changed the business landscape by focusing on lowering costs.

Competition can be harmful to a company on its revenue (or demand) side, but can be very helpful to the same company on its cost (or supply) side. The company can shop around with various suppliers and repeatedly drive the cost of its inputs lower. We will see an example of this in our later section on the homeschool dinner.

In a perfectly competitive market, a company continues producing a good or service until its marginal revenue (MR) falls to equal its marginal cost (MC). When MC > MR, then the company is better off not producing the good. There is usually no point in making something that is a money-loser, unless it attracts profits in a different way (that is known as a loss leader that attracts products for other goods and services of a company).

IV. Assignment

Read and, if necessary, reread the above lecture. The Wikipedia entry on perfect competition is recommended reading: http://en.wikipedia.org/wiki/Perfect_competition

Homework questions:

  1. The best friend of free enterprise is ___________.
  1. Describe how you can use competition to help motivate yourself to accomplish a goal.
  1. Suppose Rebecca and Sarah own a widget factory having fixed costs of $10,000. They held a meeting and determined that a widget sells for $5,000. They then found that, in addition to the $10,000, they will have variable costs of $2,500 for each widget they make. Worse, the factory can make only 3 widgets in an entire year! Someone offered to buy their factory for $10,000. Should they sell it?
  1. After a parent complained about her child not making the honor roll in a public school in Tennessee, it abolished the honor roll entirely. What do you think will happen to the quality of the work of the students in the school afterwards? Why?
  1. Assume Michael sells widgets. One day, he visited Wal-Mart to see if he could sell it some widgets. Wal-Mart said it has good new and bad news. The good news is that it wants high volume. The bad news is that it wants a price so low that Michael’s MC=MR for every unit sold to it. Should Michael agree? Explain.
  1. Suppose Patricia and Joshua own a company that has marginal cost (MC) = $9, average total cost (total cost divided by total output) = $11, average variable cost (average cost of variable inputs, like labor and materials) = $5 and price of the sold good (P) = $8. Should Patricia and Joshua make any additional goods at these numbers? Should they shut down their company?
  1. Suppose you are running a dinner event at a free facility that has 24 tables seating 8 apiece. Your marginal cost (MC) is $15 per person. Suppose your speaker costs $3500 in fees and expenses. Suppose your demand curve is this: at price P=$15, quantity Q=200; at P=$35, Q=120; at P=$50, Q=70; at P=$60, Q=40; at P=$150, Q=7. How would you price and market your tickets?
  1. One of the greatest benefits of competition is accountability. Do you agree? Explain.
  1. Review the conditions for perfect economic competition. Now develop new conditions that you think would establish a perfectly competitive presidential election, where political principles alone determine the outcome.