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Donald Boudreaux: On the role of competition |

Donald Boudreaux: On the role of competition

Economists and the general public have long looked favorably upon competition. Understandably so. Compared to firms that face competition, monopolists have great leeway to jack up their prices. Monopoly power allows its possessors to profit unjustly at the expense of consumers.

Yet competition in the reality is about much more than keeping prices as low as possible. Competition is essential for discovering just what goods and services consumers want most intensely, as well as the most efficient ways of producing those goods and services.

We only know what consumers want because businesses experiment with new and different product offerings, and consumers choose to buy or reject these new offerings. If lots of consumers like that new flavor of toothpaste well enough to buy it, then that flavor of toothpaste will continue to be produced. If only a small handful of consumers like that new ramen restaurant, it will soon close down. It’s only by allowing creative entrepreneurs to compete against existing businesses by offering new products that we discover what consumers really want.

The same is true of discovering just how outputs are best produced. Nearly every good or service can be produced in countless ways. Wheat can be produced using lots of workers each with a hand-held tool, or with a small number of workers each with an advanced farming machine. The wheat grower will choose the method that is likely to result in the highest profit to him. But it is impossible to determine with certainty beforehand which method of production is the most efficient. Quite often this determination can be made only by allowing businesses to experiment with whatever methods they choose and to see which turn out to be profitable and which do not.

When firms merge, such as AT&T and Time Warner, no one knows for certain if the larger firm will improve the quality of its offerings or lower the costs of producing them. The leaders of the merging firms predict this happy outcome. They anticipate that the improved quality or lower costs will increase the firm’s sales. Yet as the old saying goes, the proof is in the pudding — or in this case, in the actual process of market competition.

If the merged firm really does manage to produce higher-quality outputs or lower its production costs, that firm will profit and remain in business. Other firms, alert to this success, will imitate it. Notice that this firm’s success depends on consumers voluntarily buying more of its outputs. But if the firm fails, for whatever reason, to profit after the merger, then it will either break itself up — as AOL-Time Warner did in 2009 — or go bankrupt.

From the perspective of AOL-Time Warner shareholders, that 2001 merger was a failure. Monday-morning quarterbacks can wag their fingers and say that it should never have been allowed. But because markets are dynamic and the future forever uncertain, the only way to discover which mergers are beneficial and which are not is to allow maximum possible scope for business people to experiment. The same is true for nearly all other business practices.

One problem with antitrust regulation is that it rests on the mistaken notion that government bureaucrats and judges know that which cannot be known — namely, just what products and business practices will best serve consumers in the future.

Donald J. Boudreaux is a professor of economics and Getchell Chair at George Mason University in Fairfax, Va. His column appears twice monthly.

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