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1.1 Introduction

Free competition is a principle which most people as a general rule tend to support. But they only rarely seem to understand why it is a good principle, and partially as a result of this, they usually do not support it in practice on all issues. Because of this, it is important to understand just why free competition is a good and important principle.

1.2 The Effects of Competition

The neoclassical school views competition to be a matter of different equilibrium states. The most basic equilibrium model upon which the others are based is the equilibrium known as Perfect competition. The perfect competition model is based on a number of assumptions, including firms being profit maximizing, the absence of entry or exit costs, homogeneous products and perfect information. Another key feature of the model is that all firms are price takers who face a horizontal demand curve. What that means is that they raise the price, no one will buy their products. It also means that of one company lowers the price, then everyone will buy from it unless the other companies follow suit. It also implies that a company can increase its production without having any effect on the price. This last point is quite crucial for reasons which will be apparent later.

The perfect competition model however contains many problems. Becauseitis often usedina way which ignores necessary fixed or semi-fixed costs for firms, it is sometimes used to misleadingly suggest that government price regulation or anti-trust regulation can improve market outcome. Because this point is not very relevant for this report, I will not elaborate upon it here, but I have elsewhere provided an example of it in the case of minimum wage legislation3. Related to the first problem is that it contains assumptions which in most markets are obviously unrealistic. For example, companies regularly try to differentiate their products and make their particular brands appear unique. Moreover, there are usually some forms of exit and entry

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http://stefanmikarlsson.blogspot.com/2009/07/can-higher-minimum-wages-increase.html

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