Understanding Competition: Beyond the Surface
Economists often praise competition as the driving force behind lower prices and improved quality in the marketplace. But what does “competition” truly entail, and how does it function in the real world?
For those outside the realm of economics, the term might evoke images of a sports contest, where there is one champion and a slew of defeated competitors. This analogy, however, falls short on several fronts.
Firstly, the notion of a sole “winner” in market transactions assumes the existence of a single, uniform product that all competitors are attempting to sell, scrambling for limited consumer dollars. While this scenario makes for an interesting academic exercise, it bears little resemblance to the reality of market exchanges. Consider the fierce loyalties of soda aficionados when you suggest that Coke, Pepsi, and RC Cola are merely interchangeable; their reactions could be quite enlightening.
Secondly, the idea that more competitors automatically leads to heightened competition is misleading. In a small town with only two hardware stores, the rivalry might be more intense than in a larger city boasting twenty such establishments. This suggests that the dynamics of competition are more nuanced than a simple headcount of rivals.
So, what does competition actually look like?
Recently, my mother experienced a furnace failure while she and her husband were away from their home in Michigan during winter. Living just two miles away, I became the designated emergency contact. The following morning, a technician arrived to diagnose the issue—though I must admit, my expertise in furnace repairs is non-existent.
The technician had me in a tight spot; no other company could resolve the issue faster, and I certainly didn’t want to risk my mom’s pipes freezing. Yet, when the bill arrived, the charges seemed completely standard—there was no exorbitant emergency fee, which I would have begrudgingly accepted given the circumstances.
Why was that the case?
This year marks the 250th anniversary of Adam Smith’s Wealth of Nations, and my furnace repair experience exemplifies Smith’s insights about competition. It transcends the textbook definition of identical firms vying over identical products, resulting in prices driven to zero. Indeed, Smith would have found the formal model of perfect competition quite foreign. Instead, he elucidated a deeper understanding of how commercial interactions shape behavior over time.
Smith recognized that markets do more than just allocate resources; they foster habits of integrity. A company that cheats may gain short-term profits, but it will struggle in the long run. Conversely, a business that engages with customers honestly builds a reputation and encourages repeat patronage, ultimately outlasting the unscrupulous competitors.
Smith referred to this as the “discipline of continuous dealings,” a concept that game theorists now call “repeated play.” When a firm anticipates future transactions—whether with the same customer or through their word-of-mouth recommendations—cooperation becomes the preferred strategy. This doesn’t imply that everyone becomes virtuous; rather, it’s the cheaters who end up suffering as their peers choose to do business elsewhere.
In the world of Yelp, Google Reviews, and social media, the furnace technician operates under the scrutiny of public opinion. His company has been established for decades and likely intends to remain in business for many more. Each service call contributes to his “continued dealing,” shaping his approach to service and pricing.
This perspective significantly alters our understanding of “market power.” The conventional narrative suggests that sellers can take advantage of buyers when there are no viable alternatives. While this can occur, it is often the case that honest interactions prevail. Competitive markets exert pressure that persists even during moments of reduced competition. The company that gouges today may face increased competition tomorrow, and its reputation will follow.
Thus, “competition” is not merely about the number of competitors present at any given time; it encompasses the ongoing potential for rivalry and the awareness that customers can choose to leave, that alternatives may arise, and that information about ethical or unethical practices circulates rapidly. These dynamics instill a discipline in market transactions that makes fair dealings almost second nature.
Two hundred and fifty years after Smith’s observations, his insights remain undervalued. Markets are not solely price-setting mechanisms; they also cultivate behavior by rewarding fairness and cooperation. In doing so, they can render ordinary self-interest indistinguishable from virtue.
Thanks to the technician’s fair practices, my mom’s pipes did not freeze, and the repair company garnered a loyal customer. If Adam Smith were to hear this tale, he would likely raise his glass of claret in approval.
