Microeconomics and the Problems of Competition and Cooperation - dummies

Microeconomics and the Problems of Competition and Cooperation

By Lynne Pepall, Peter Antonioni, Manzur Rashid

The situation of many companies following their own interests leads to competition. In almost all circumstances, competition is a pretty good thing, because it can lead to lower costs or more innovation.

For example, if only one store operates in your area, it may be able to get away with selling milk for $5 a gallon. But if other stores get in on the act, the competition leads to the price falling and stores trying to keep their costs low.

Businesses typically face a competitive environment, but inside the business people cooperate and work together to achieve common goals. Microeconomics studies cooperation as often as it studies competition. The desire is to understand what type of circumstances lead people to choose to cooperate or compete and what are the pitfalls of competition and cooperation.

Even businesses that are competitors in one area sometimes form alliances in others — Apple’s relationship with Motorola in the early 2000s being just one example.

Microeconomists are often accused of overselling the benefits of competition, but they also point out that cooperation can be perilous too. When a group of companies with large shares of a relevant market work together, the result is often harmful to the public, as Adam Smith pointed out. Working together in that way is illegal, not surprisingly. Similarly, a trade union where a lot of people work together to get the best bargain with their industry can have negative effects on anyone not a member of that union. Microeconomists go on to investigate all these possibilities.

Realizing why authorities regulate competition

At some point, no matter where they operate in the world, businesses have to deal with the legal institutions that govern the region where they operate. In general, a lot of basic rules restricting how business is conducted underpin every legal market, from ensuring that products are what businesses say they are to not allowing companies to exploit market dominance. But if a basic tenet of microeconomics is that trades and markets emerge with no one in charge, why do we need such governance?

Because markets in reality are far from perfect. Sometimes market trades impose costs, such as environmental costs, upon people who aren’t involved in that particular market. Sometimes restricting trade or conduct in a given market leads to better behavior. But perhaps the most interesting reason for regulation is because of what happens when a competitor gets too successful. When that happens, the company makes larger profits, which is good for shareholders. But suppose market conditions are such that no company can set up as a rival — maybe the costs involved in being in that market are too high, or the successful competitor holds the entire supply of a key resource.

The idea is that you don’t want a company to exploit its advantage in a way that leads to too many losses for everyone else. At this point, competition law can step in and place restrictions on what a company can and can’t do, because the costs of runaway success can be very large indeed.

Considering antitrust law

Antitrust law is at the very top of things that a society can do to make sure that markets don’t hurt the public good. The purpose is to ensure that if a market isn’t competitive, at least the costs can be minimized. Antitrust law is the last line of defense against the worst kinds of behavior, preventing the biggest companies from prejudicing competition.

The idea is that competition is good, so stopping the biggest companies from subverting competition requires constant vigilance. In practice, it means that part of the legal system switches from treating everyone equally to treating those companies with the biggest market shares differently from smaller ones.

Many rules are in place to stop large companies from subverting competition:

  • Predatory pricing makes it illegal for a company to drop its prices below cost to deter or drive out potential rivals.

  • Merger rules prevent a large company from buying out its competitors and ensure that competition is achieved where possible.

  • Behavioral remedies stop the largest competitor from owning a key resource. For instance, if you own a network, you aren’t allowed to offer your own content providers preferential prices to access the network.

In all these cases, companies are treated differently because everyone recognizes that if competition fails, everyone loses out in the long run — ultimately getting poorer quality goods at higher prices.

Microeconomists examine all these cases with models that compare competitive outcomes to those achieved by noncompetitive organizations. In most situations, the intuition microeconomists form is that competition is good. But not always. In some cases, competitive markets just don’t produce a good, and in others the diversity of products isn’t as good in a competitive market, and so unlike many political partisans on the right and left, economists — as a whole — aren’t ideologues about this idea.