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{{Economics_Lectures}}

{{Economics_Lectures}}

In this Lecture we introduce the concept of "perfect competition."  To get to "perfect competition," let's first learn what "competition" is, and let's learn it well.

In this Lecture we introduce the concept of "perfect competition."  Let's first learn what "competition" is, and let's learn it well.

According to the dictionary, "competition" was not first used in 1605. What conclusion might an historian draw from that simple observation? Shakespeare had completed nearly all his plays by then, and a search of all of Shakespeare's works reveals that he never used the word, not even once.<ref>http://www.opensourceshakespeare.org/</ref>  Imagine that!

According to the dictionary, "competition" was not first used in 1605.  Shakespeare had completed nearly all his plays by then, and a search of all of Shakespeare's works reveals that he never used the word, not even once.<ref>http://www.opensourceshakespeare.org/</ref>  Imagine that: Shakespeare knew nothing of the word.

Leonardo da Vinci competed with Michelangelo, and the world benefited from their achievements.  In math and physics, Isaac Newton competed with Gottfried Leibniz and a wellspring of accomplishments flowed.  Sports rivalries are famous also for bringing out the best in each side.

But perhaps competition has always existed.  Leonardo da Vinci competed with Michelangelo, and the world benefited from their achievements.  In math and physics, Isaac Newton competed with Gottfried Leibniz and a wellspring of accomplishments flowed.  Sports rivalries are famous also for bringing out the best in each side.

In business, it is the competition that brings out the best service, highest quality goods, and lowest prices.  Wal-Mart competes with Target and K-Mart.  Federal Express competes with UPS for shipping services.  Phone companies compete with either for cell phones and home service.  Television stations compete with each other.  Fox News competes with CNN.  Politicians compete with each other to win elections.  The dictionary definition of the "free market," which was first used in 1907, is "an economic market operating by free ''competition''."<ref>Merriam-Webster's Collegiate Dictionary (10th Ed. 1994).</ref>

In business, it is the competition that brings out the best service, highest quality goods, and lowest prices.  Wal-Mart competes with Target and K-Mart.  Federal Express competes with UPS for shipping services.  Phone companies compete with either for cell phones and home service.  Television stations compete with each other; Fox News competes with CNN.  Politicians compete with each other to win elections.  The dictionary definition of the "free market," a term was first used in 1907, is "an economic market operating by free ''competition''."<ref>Merriam-Webster's Collegiate Dictionary (10th Ed. 1994).</ref>

We all think we know what "competition" is, but can we define it precisely?  Here's one attempt:  "competition is the rivalry by people or companies for achievement, success, customers, attention or praise."  We could define competition in other ways, by using other powerful terms developed in this course.  For example, we could define competition in terms of efficiency:  "competition is the process that most efficiently identifies the best in something."

We all think we know what "competition" is, but can we define it precisely?  Here's one attempt:  "competition is the rivalry by people or companies for achievement, success, customers, attention or praise."  We could define competition in other ways, by using other powerful terms developed in this course.  For example, we could define competition in terms of efficiency:  "competition is the process that most efficiently rewards the best."

When wer are a customer, we like competition to attract our spending money.  Competition means companies will be constantly trying to offer a lower price and better deal than their rivals.  That saves us, as customers, money, and allows us to obtain better goods and services.  Without the competition, we would be stuck with companies that charge as much as they like, and provide as poor quality goods and services as they want.  Competition rewards hard work; the lack of competition encourages laziness.

When we are a customer, we like competition for our spending money.  Competition means companies will be constantly trying to offer a lower price and better deal than their rivals.  That saves us money, as customers, and allows us to obtain better goods and services.  Without the competition, we would be stuck with companies charging as much as they like, and providing as poor quality goods and services as they want.  Competition rewards hard work; a lack of competition encourages laziness.

The economic definition of competition should include rivalry for resources in addition to customers, as companies can compete with each other for workers too.  So let's define competition in economics as the "rivalry for goods, services or resources among different buyers or sellers."  Perhaps you can improve on that definition.

The economic definition of competition should include rivalry for resources in addition to customers, as companies can compete with each other for workers too.  So let's define competition in economics as the "rivalry for goods, services or resources among different buyers or sellers."  Perhaps you can improve further on that definition.

It helps to look at the "perfect case," and that is "perfect competition."  How should we define that?

It often helps to look at an ideal case, and that is "perfect competition."  How should we define that?

==Perfect Competition==

==Perfect Competition==

Perfect competition is a set of conditions that are ideal for someone ''benefiting'' from the competition, such as a consumer of a good who wants the best quality and the lowest price.  The conditions are these:

Perfect competition is the set of conditions that are ideal for someone ''benefiting'' from the competition, such as a consumer of a good who wants the best quality and the lowest price.  The conditions for perfect competition are these:

1.  '''Many buyers and sellers.'''  You can't have perfect competition without a lot of competitors!  In a classroom situation, two or even five students competing for a good grade may not be enough.  If a few get lazy, then all may stop working.  But in a large group of students, you can be sure that someone is working hard.  Similarly, the more gas stations in an area, the more the competition.

1.  '''Many buyers and sellers.'''  You can't have perfect competition without a lot of competitors!  In a classroom situation, two or even five students competing for a good grade may not be enough.  If a few get lazy, then all may stop working.  But in a large group of students, you can be sure that some are working hard.  Similarly, the more gas stations in an area, the more the competition for customers of gasoline.

2.  '''Goods that are perfect substitutes for each other.'''  The ability to substitute one for the other is what makes the market so perfectly competitive.  Pencils are so inexpensive because there are so many perfect substitutes for them, as one brand of pencil substitutes easily for another.  Any variance in quality would prevent perfect substitution, and frustrate perfect competition.

2.  '''Goods that are perfect substitutes for each other.'''  The ability to substitute one for the other is what makes the market so perfectly competitive.  Pencils are so inexpensive because there are so many perfect substitutes for them, as one brand of pencil substitutes easily for another.  Note that any variance in quality would prevent perfect substitution, and frustrate perfect competition for a particular level of quality; if there were only one brand for a high-quality pencil, then there would not be perfect competition for it.

3.  '''Perfect knowledge in the market.'''  Fully informed consumers and suppliers are also necessary for perfect competition.  If Wendy’s is selling a hamburger at a lower price than McDonald’s or Burger King, but no one knows about Wendy's, then the competition is not going to be perfect.  McDonald's and Burger King would be able to continue to sell overpriced hamburgers.

3.  '''Perfect knowledge in the market.'''  Fully informed consumers and suppliers are also necessary for perfect competition.  If Wendy’s is selling a hamburger at a lower price than McDonald’s or Burger King, but no one knows about Wendy's, then the competition is not going to be perfect.  McDonald's and Burger King would be able to continue to sell overpriced hamburgers.

4.  '''Perfect mobility of resources.'''  Put another way, the competitors must have identical costs for their supplies.  If one competitor, say a gas station, has higher costs than the others, such as a higher price of gas from its suppliers, then it is not going to be able to be competitive.   

4.  '''Perfect mobility of resources.'''  Put another way, the competitors must have identical costs for their supplies.  If one competitor, say a gas station, has higher costs than the others, such as a higher price of gas from its suppliers, then it is not going to be able to be competitive.   

(Additionally, there cannot be any price discrimination.  Ignore this point if you do not recall what "price discrimination" is!)

(Additionally, there cannot be any price discrimination.  You can ignore this point if you do not recall what "price discrimination" is.)

Every Economics exam has a few questions about "perfect competition," and you will answer them correctly by remembering the above four points and applying them correctly.

Every Economics exam has questions about "perfect competition," and you will answer them correctly by remembering the above four points and applying them correctly.

Beyond the value of acing exams, perfect competition is useful as an ideal against which to analyze imperfections.  Understand why a market does not have perfect competition, and then it becomes easier how to deal with that market, or how improvements might occur.   

Beyond the value of doing well on exams, perfect competition is useful as an ideal against which to analyze imperfections.  Understand why a market does not have perfect competition, and then it becomes easier to know how to buy, sell or invest in that market, or how improvements might occur.   

An investor in the stock market may want to stay away from companies that are in perfectly competitive markets, because the competition will reduce prices and profits for the companies.  But a buyer or consumer prefers a perfect competition because it lowers price and improves quality!

An investor in the stock market may want to stay away from companies that are in perfectly competitive markets, because the competition will reduce prices and profits for the companies.  But a buyer or consumer prefers a perfectly competitive market because it lowers price and improves quality!

If you are the owner of a firm, do you like competition?  No, not when other firms are competing against you, because that competition will cause you to lower your prices and lose profit.  But you do want want perfect competition among your suppliers, because that will help keep your costs lower.

If you are the owner of a firm, do you like competition?  No, not when other firms are competing against you, because that competition will cause you to lower your prices and lose profit.  But you do want want perfect competition among your suppliers, because that will help keep your costs lower.

'''''Exam tip''''': On a typical Economics exam, "perfect competition" or "perfectly competitive" will be in nearly 20% of the questions.  When you see that in a question, it means that prices are at their lowest possible point.  The competition causes everyone to lower their prices down to their minimum.  Profits are zero.  If the labor market is perfectly competitive, then everyone is making the lowest possible wage.  These is no excess or surplus or "fat" or inefficiencies in a perfectly competitive market.

'''''Exam tip''''': On a typical Economics exam, "perfect competition" or "perfectly competitive" will be mentioned in nearly 20% of the questions.  When you see that in a question, it means that prices are at their lowest possible point.  The competition causes everyone to lower their prices down to their minimum.  Profits are zero.  If the labor market is perfectly competitive, then everyone is available to work at the lowest possible wage.  These is no excess or surplus or "fat" or inefficiencies in a perfectly competitive market.

== Example of Perfect Competition: Sports ==

== Example of Perfect Competition: Sports ==

1.  Many buyers and sellers?  Yes.  There are many teams competing for support of fans, and many fans choosing between different teams to support.

1.  Many buyers and sellers?  Yes.  There are many teams competing for support of fans, and many fans choosing between different teams to support.

2.  Goods that are perfect substitutes?  Yes (services in this case).  It's easy to stop rooting for the New York Giants and start rooting for another team, such as the New York Jets.

2.  Goods that are perfect substitutes?  Yes (entertainment services in this case).  It's easy to stop rooting for the New York Giants and start rooting for another team, such as the New York Jets, or at least it should be easy!

3.  Perfect knowledge in the market?  Yes, everyone knows the scores and the ticket prices are published for anyone who is interested.

3.  Perfect knowledge in the market?  Yes, everyone knows the scores and the ticket prices are published for anyone who is interested.

But wait, you say, there is only one NFL.  It looks like there is perfect competition ''within'' the NFL, but there is no other league that has perfect competition with the NFL.  That is true:  the NFL itself has little or no competition.  There was a USFL that tried to compete against it many years ago, but it failed.  In the 1960s, there was an "AFL" that did successfully compete against the NFL, and they merged to form what we call the NFL today.

But wait, you say, there is only one NFL.  It looks like there is perfect competition ''within'' the NFL, but there is no other league that has perfect competition with the NFL.  That is true:  the NFL itself has little or no competition.  There was a USFL that tried to compete against it many years ago, but it failed.  In the 1960s, there was an "AFL" that did successfully compete against the NFL, and they merged to form what we call the NFL today.

Consider these two alternatives for picking players for a football team.  The first approach would be decide who you think would do best for each position based on their family background, their height and weight, an interview, and your intuition.  The second approach would be to have tryouts for each position and select the player who did the best at the tryout competitions.  Obviously the result would be much better with the second approach, as many players would be surprisingly good (or bad) at certain positions and it would become obvious during the competition.  Use competition for your benefit to obtain the best.

Consider these two alternatives for picking players for a new football team.  The first approach would be to decide who you think would do best for each position based on their family background, their height and weight, an interview, and your intuition.  The second approach would be to have tryouts for each position and select the player who did the best at the tryout competitions.  Obviously the result would be much better with the second approach, as many players would be surprisingly good (or bad) at certain positions and it would become obvious during the competition.  Similarly, use competition for your own benefit to obtain the best.

== Benefits of Competition ==

== Benefits of Competition ==

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 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.

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.

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 a 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.

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.

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.  This is known as "antitrust law": it makes anti-competitive behavior by businesses illegal.

== Competition and Innovation ==

== Competition and Innovation ==

==Assignment==

==Assignment==

Read and, if necessary, reread the above lecture.  Our midterm exam is in two weeks and this assignment is lighter than usual so that you can begin preparing for the exam this week.  But do answer 5 out of the following 6 questions:

Read and, if necessary, reread the above lecture.  Our midterm exam is in two weeks and this assignment is lighter than usual so that you can begin preparing for the exam this week.  But do answer 6 out of the following 7 questions:

1.  Identify the four elements of ''perfect'' competition.

1.  Identify the four elements of ''perfect'' competition.

2.  Describe how you can use competition, perhaps even competing with yourself, to motivate you to achieve more.

2.  Describe how you might use competition, perhaps even competing with yourself, to motivate you to achieve more.

3.  We are going to have our midterm in two weeks.  Think of a question that you would like to see answered or clarified at the next class.

3.  We are going to have our midterm in two weeks.  Think of a question that you would like to see answered or clarified at the next class.

6.  Suppose you decide you could profitably set the price for a homeschool dance at $15 per ticket, and it would have attracted $150 people.  You also determine that 50 out of the 150 people who would have attended would have paid $20 per ticket and 10 out of the 150 would have paid $25 per ticket, and 5 out of the 150 would have paid $30 per ticket, because they would have enjoyed and benefited so much from it.  However, the homeschool dance was never held because no one "got around to it."  What is the loss in wealth or consumer surplus due to the fact that the event was ''not'' held?

6.  Suppose you decide you could profitably set the price for a homeschool dance at $15 per ticket, and it would have attracted $150 people.  You also determine that 50 out of the 150 people who would have attended would have paid $20 per ticket and 10 out of the 150 would have paid $25 per ticket, and 5 out of the 150 would have paid $30 per ticket, because they would have enjoyed and benefited so much from it.  However, the homeschool dance was never held because no one "got around to it."  What is the loss in wealth or consumer surplus due to the fact that the event was ''not'' held?

===Honors===

===Honors===

7.  Define the term "competition" in a new way by using another powerful term developed in this course.

7.  Define the term "competition" in a new way by using another powerful term developed in this course.

8. Suppose the ''labor'' market is perfectly competitive, and that there is a minimum wage above the market rate.  Then suppose that the supply of labor increases.  Explain what happens as a result.

8. Suppose the underlying ''labor'' market is perfectly competitive, but there is a minimum wage above the market rate.  Then suppose that the supply of labor increases.  Explain what the result is.

9.  What is the firm's profit or loss when Q=0 in the honors discussion above?  (Answer simply in terms of another cost measure.)  Is the firm profitable?   

9.  What is the firm's profit or loss when Q=0 in the honors discussion above?  (Answer simply in terms of another cost measure.)  Is the firm profitable?