August 23, 1996

Competition and the Market

The trouble with the profit system has always been that it is highly unprofitable to most people.

E.B. White 1944

If you ask any teenager how to raise a child, he/she will have all of the answers. Ask someone who has raised children and you will likely get a shrug and a "how should I know?" It is the same thing with economics. Every now and then someone writes a successful book that gives us the answer to economic problems. Karl Marx had one set of answers and other economists had others. All were wrong. There are times when laissez faire works very well and there are times when it is a disaster. The same can be said of socialism. All that you have to do is look at Russia to see the failure of socialism and at a number of South American countries to see the disaster of capitalism.

I will now do what I have just warned you against -oversimplify. The modern economic process begins when an inventor and entrepreneur invents a gadget that lots of people want or need. From here, all sorts of things can happen: nobody finds out about it and his company dies; his product catches on and people buy his Widget. He sells it for $20 and it sells in the stores for $40. With his profits he builds an efficient plant that enables him to build Widgets for $1. Money rolls in. At this point he can do any of a number of things; he can take the money, buy an estate and retire to it; he can use some of his profit to invent and develop other products; he can develop more efficient ways to produce his product or he can improve the product, or he can sell his company to a conglomerate. The number of possibilities are vast.

Then other entrepreneurs see that our inventor-entrepreneur is making big money, so they decide to go into the business. They see that he is selling something for $20 that costs him $1 to make. As any fool can see, you can still make big bucks by selling the same product for $15, so in comes competition. Soon we have half a dozen factories making the same or a similar gadgets. The price of the product drops and lots of people buy lots of Widgets. In order to stay in business, companies have to figure out how to sell more Widgets or .... by now you can see how complicated the whole picture becomes. It becomes so complicated that making accurate predictions becomes impossible. All of the theories' ability to predict break down.

There is no doubt in my mind that the principles of capitalism can work well. I am equally certain that there are times and situations where it doesn't work.

Let us look at these 6 companies that are producing Widgets. As a result of the intense competition, three companies fail. The other three companies are doing fairly well, but if they continue competing, two more, or all three companies, will go under. So, one evening, at a party at a meeting of the National Association of Manufacturers, the company executives decide that they will not cut prices beyond the point where all of the companies can survive and thrive. Either they will all hold the line on prices, or only one manufacturer will be left, and he can charge whatever he wants because he no longer has competition. Then other inventors invent other products and before long the nation is wallowing in prosperity. Everyone has a job and the money to buy Widgets and other Doodads and Gadgets -not to mention food, clothing and shelter.

If the system works so well, why do we have recessions, depressions, wars, unemployment and misery? So why?

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