14 May 2007

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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