Economists emphasize the critical role of competition in markets as a means to lower prices and enhance quality. However, what exactly does “competition” entail, and how does it function?
For many outside the field of economics, the term brings to mind the concept of a sporting contest, where one emerges victorious while others are left behind. However, this analogy breaks down in at least two key ways.
Firstly, envisioning a single “winner” in market exchanges would imply that all competitors are offering the same product, competing solely for limited consumer dollars. While this makes for an interesting hypothetical scenario in classrooms and textbooks, it does not accurately reflect how market exchanges function in reality. For instance, telling someone with a discerning palate that Coke, Pepsi, and RC Cola are “essentially the same” will likely meet with strong disagreement.
Secondly, the idea that a single winner with many losers would suggest that increasing the number of competitors inherently boosts competition is misleading. For example, the competition among just two hardware stores in a small town can be far more intense than that between twenty stores in a larger city.
So, what truly defines competition?
Recently, my mother and her husband faced a furnace failure while away from home—in the middle of winter in Michigan. Since they reside just two miles from me, I was their designated emergency contact. The very next morning, a technician arrived to assess the situation. Admittedly, my technical expertise left me clueless; all I knew was that a specific part required replacement.
The technician had me in a precarious position; no other companies in town could resolve this issue quickly, and I was intent on preventing my mother’s pipes from freezing. Nevertheless, when I received the invoice, the charges were entirely standard. There was a reasonable fee for parts and labor, devoid of any emergency service markup—something I would have accepted given the circumstances.
Why was that the case?
This year marks the 250th anniversary of Adam Smith’s Wealth of Nations, which provides keen insight into the nature of competition. It’s not merely about identical firms producing identical goods and engaging in a price war until (economic) profit dwindles to zero. In truth, Smith would not have fully recognized the formal model of perfect competition. However, he did clarify that commercial activities shape behaviors over time.
Smith acknowledged that markets not only allocate scarce resources effectively but also foster habits of fair dealing. A firm that resorts to deceit might realize short-term gains but will ultimately struggle in the long run. Conversely, a business that treats and charges customers honestly cultivates a strong reputation, attracts repeat customers, and thrives over time compared to dishonest competitors.
Smith referred to this dynamic as the “discipline of continuous dealings,” a concept echoed by game theorists as “repeated play.” When a firm anticipates future transactions, whether with the same customer or with others to whom that customer may relay their experiences, cooperation (rather than deception) becomes the prevailing strategy. This perpetuates not because individuals become morally upright, but because those who cheat face repercussions when their market counterparts choose alternative providers.
The furnace technician operates within a landscape shaped by Yelp, Google Reviews, and social media. The company has built a lasting reputation over the decades, with aspirations for continued success. Every service interaction contributes to his ongoing business relationship, influencing his conduct.
This perspective fundamentally alters our understanding of “market power.” Conventional wisdom suggests that when a seller encounters a buyer with limited alternatives, exploitation ensues. While this can occur, it is frequently more common to observe honest interactions. Competitive markets exert influences that endure even during moments that appear non-competitive. A company that charges excessively today may face more competition tomorrow, and its reputation will inevitably be affected.
Thus, “competition” is not merely about the number of rivals present at any given time. Rather, it encompasses the persistent potential for rivalry, the awareness that customers can switch their loyalties, that alternatives may arise, and that the word about both positive and negative experiences circulates rapidly. These factors ensure that market exchanges adhere to principles of fairness, making ethical interactions almost automatic.
Two and a half centuries after Smith’s observations, his insights remain largely undervalued. Markets function not only as mechanisms for setting prices but also as catalysts for behavior that values integrity and cooperation. In this way, they can align ordinary self-interest closely with virtuous conduct.
Thanks to the technician’s efforts, my mother’s pipes were saved. The repair company secured a devoted customer in the process. Were he to hear this story, Adam Smith would likely take a sip of his claret and nod in agreement.
