Non-Competitive Markets

This post is inspired by one of my friends, who asked me why it is that banks require you to pay fees and all sorts of other things, while credit unions generally do not.

Now, I'm not an expert when it comes to banks and other financial institutions. That's not what I'm interested in. However, I know the signs of a market that is not competitive when I see them. Or, at least, assuming that the above statement is correct and the services provided by a bank and a credit union are substitutes, the overall market is not competitive one.

Hence, this post is going to talk about what causes a market to become not competitive. Fairly soon I'll also have a post up talking about whether or not a non-competitive market is necessarily a bad thing, but for the moment we will leave issues of social surplus and equity in our other pants.

A market in perfect competition is the economic version of a perfect gas. That is, it doesn't exist, but it has a lot of nice properties that are theoretically important. Perfectly competitive markets have a large number of buyers and sellers, and all goods in the market are perfect substitutes for one another. No business makes a profit, and social surplus is maximized. There are a number of other minor and major theoretical details that aren't particularly important here.

What is important is to understand the criteria that define a competitive market. First, goods should be perfect substitutes. The further from perfect substitutes goods in the same market are, the less competitive the market is as a whole. The most important case in which goods are not substitutes is when product differentiation occurs, usually in the case of certain goods being better or worse. Brands and brand loyalty are also a good example of this.

The second condition is that there must be a large number of buyers and sellers. The obvious opposite case is a monopoly, a market with only one seller. There are also monopsonies, markets with only one buyer. Both show how important this particular condition is for determining if a market is competitive.

Non-competitive markets come into existence because businesses want to make a profit. In a truly competitive market, no profits are made. Again, many theoretical reasons that we will skip here, but the main important one is that, as a result of the large number of buyers and sellers and lack of product differentiation, no business can sell a good at anything more than cost without having zero customers.

Transitions from competitive to non-competitive occur, then, because businesses want to make money which, I think, is a fact we can all agree on. They go about doing this in many different ways, but they are all aimed at either positive differentiation of their own product or reducing the number of other businesses in the market.

Regardless, it can then be said that the inexorable profit seeking activity of business people is what causes a market to become less competitive, something I think some of you will find quite surprising.

Anyways. Some further examination of competition will be in order later this week. Questions, comments, suggestions, and your least favorite word in the English language can all be left in the comments section if you so wish.