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Competition: Real and Mistaken

Here’s a letter to the Wall Street Journal:

Peter Thiel notes that, despite its being “considered both the ideal and the default state in Economics 101,” economists’ theory of perfect competition doesn’t remotely describe the realities of actual capitalist rivalry (“Competition Is for Losers,” Sept. 13).  He’s right.

As explained by the great economist Harold Demsetz, the theory of perfect competition is not a theory of competition at all.  Instead, it’s a theory of the formation of prices under conditions of extreme decentralization.*  Yet by calling it a theory of competition (perfect, no less!), careless economists – as well as antitrust officials – naively mistook this theory meant to describe one thing (price formation) as being a theory meant to describe something altogether different (market competition).  And so it’s as unsurprising as it is regrettable that when the actual process of real-world market competition reveals itself to be nothing like anything found in the theory of perfect competition, far too many economists and bureaucrats accuse real-world markets of being less than ideally competitive – of being infected with strains of monopoly power.

In fact, as Mr. Thiel recognizes – and as Austrian economists such as Ludwig von Mises, Joseph Schumpeter, F.A. Hayek, and Israel Kirzner have always insisted – entrepreneurs who innovate in ways that create unique market niches that yield temporary above-normal profits are not really monopolists at all.  Instead, they are the essential drivers of genuine, dynamic, and consumer-friendly competition.

Donald J. Boudreaux
Professor of Economics
Martha and Nelson Getchell Chair for the Study of Free Market Capitalism at the Mercatus Center
George Mason University
Fairfax, VA  22030

* Harold Demsetz, Economic, Legal, and Political Dimensions of Competition: The De Vries Lectures in Economics (Amsterdam: Elsevier Science, 1982).  [See also here.]