The Assumptions of Perfect Competition: Lesson 5

Assumption 5: Producers and consumers have perfect knowledge of the market

Of all the assumptions of perfect competition the assumption about knowledge of opportunities to buy and sell this one relating to information has failed the test of time perhaps worst of all. In Adam Smith’s 18th-century market it was a reasonable suggestion that you might be able to have ‘perfect information’ about all the goods between which you were making your choice. There were, let’s say, three shoemakers and you could stroll from one stall to the next, and on to the third. In markets and fairs of this time, producers of similar goods helpfully located themselves alongside one another, which is why we are left with street names such as Butcher’s Row or Shoe Lane.

Pretty nearly perfect information was possible then, because there was such a limited range of goods. Proponents of market capitalism frequently list the expanded range of goods as one of the achievements of their favoured economic system, yet they have failed to consider how this impacts on the assumption about perfect knowledge. With millions of goods currently available how could we possibly know about all of them? Evidence that we do not comes in the form of advertising campaigns like the one by Superdrug claiming ‘If you find it cheaper elsewhere, we’ll refund twice the difference’. Clearly, if you had perfect information you would know it was cheaper somewhere else to start with and, if you wished to ‘maximise your utility’ buy it there. Such advertising campaigns manipulate us on the basis of our well-founded fear that our knowledge of the market and its goods is far from perfect.

This assumption comes in two parts, and far from reality though the side relating to consumers is, that relating to producers takes us once again into the realms of fantasy or farce. For the assumption to be true, sellers of goods have to have perfect information about all the opportunities to sell. As Sloman puts it: ‘Perfect knowledge means that potential entrants know immediately of a change in market circumstances which will yield them better rewards than can be earned elsewhere’‘Producers are fully aware of prices, costs and market opportunities. But in the global marketplace this would have to include selling opportunities right across the globe. In reality the only players who have this sort of reach are well-established, well-capitalised corporations. What chance do you or I have of finding out about market opportunities in Montevideo or Novosibirsk?

The focus of this point about the perfect knowledge of sellers is that they must have a knowledge of market opportunities. This will fulfil the necessary constant entry of new sellers which is the way that prices are kept low and racketeering is prevented, the basis of why the market system is a good system for distributing goods in the first place. Potential entrepreneurs are expected to scan the economy for market opportunities for them to exploit, which are those opportunities where existing suppliers are making the largest profits, ‘abnormal profits’, as economic theory calls them. But how are we to know the size of these profits, normal or abnormal, when such knowledge is constrained by commercial confidentiality. Modern corporations pay accountants to distort the financial figures they are required to declare, while most others are kept secret to protect their commercial position.

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The Assumptions of Perfect Competition: Lesson 2

Assumption 2. There are so many firms in the industry that each one . . . has no power whatsoever to affect the price of the product

The second first assumption is intended to guarantee that neither individual buyers nor individual sellers can have undue power within any market. This is because, with so many sellers, it would be impossible to operate an effective cartel, since the cost of finding information from so many sources would preclude such an arrangement. Again, because there are so many sellers, none can individually influence the price of the good s/he is selling. Large buyers might also come to have too much power in a market, so the assumption applies also to the demand side of the market.

Is this a realistic view of how modern markets operate? In reality, it flies in the face of the consolidation that has typified capitalism at least since it was critiqued by Marx (what a fantastic beard!). Perhaps in this Information Age we should be most concerned about the heavy consolidation in the world of media, as demonstrated by the merger of AOL and Time-Warner, two of the largest global media corporations, in 2001. Since the merger the group has gone from strength to strength, now out-competing other providers of high-speed internet connections and seeing profits increase by 76% in the last quarter of 2004.

Let us carry out that manoeuvre so detested by economists and test out this assumption against the reality of the market for food in the UK at the beginning of the 21st century. The reality is that the market is dominated by a small number of very powerful players—the supermarkets. As middlemen, standing between producers and consumers, they both buy and sell food, and ensure that what economic theory might consider the ‘buyers’ and ‘sellers’ have to meet their in needs in terms not only of price, but also in terms of quality. According to Corporate Watch research, in 2000 the major supermarket chains controlled 88 per cent of the UK food market, a concentration of retail power far greater than in continental EU countries or the USA. Later that year analysts predicted that the number of major players would be down from the existing five—Tesco, Sainsburys, Safeway, Asda, and Somerfield—to just two.

So much for competition: without a large number of potential entrants to the market, what mechanism does the market offer to constrain their behaviour? This assumption relies on a separate sub-theory focused around the concept of ‘barriers to entry’. In order to ensure that there are plenty of buyers and sellers in the market, there must be nothing to stop the potential market players from entering the market, no ‘barriers’. Competition only works when there are large numbers of suppliers who cannot unduly influence our purchasing decisions or preventing other producers from entering the market and improving on their offer to us as consumers.

This view may have made sense why you consider the 18th-century market that Adam Smith visited, where he might have bought meat, potatoes and shoes, but it has little relevance in a complex, modern economy where purchasing decisions are based on advertising and goods do not reach the market without many years of development and massive R&D investment. Or to a market where a new item cannot reach the consumer's attention without massive investment in branding and advertising.

Parkin and King deal with advertising as follows: ‘To the extent that advertising provides consumers with information about the precise nature of the differentiation of products, it serves a valuable purpose, enabling consumers to make a better product choice’. Sloman deals with advertising as follows: ‘There is no point in advertising under perfect competition, since all firms produce a homogeneous product (unless, of course, the firm believes that by advertising it can differentiate its product from its rivals’ and thereby establish some market power; but then, by definition, the firm would cease to be perfectly competition’ (p. 156). Trying to imagine what kind of advertising might conform to this the world of the perfectly competitive theory Mr. Cholmondley-Warner sprung into my head, kindly pointing out in his received pronunciation that Mr. McVitie is now producing his digestive biscuits with chocolate on top. If this was all advertising were about why would companies spend millions on it every year? Why would there by whole journals dedicated to informing company executives of the most effective ways to manipulate the minds of potential buyers?

In reality, the business of a corporation in the global economy focuses on holding its market share and defending it against all-comers. The business of corporate capitalism is not about perfect competition but about obstructing competition. This is done not only through creating and defending the corporation’s unique identity through its brand, but also through investing in advertising and PR to support its brand and litigation to attack those who transgress it, and through concealing virtually everything about its operations, from the details of how its products are made (remember the Coca Cola secret recipe?) to how it spends its profits. Tweet