Competitive Markets: Foundations of Free Enterprise

The Foundations of Free Enterprise
by Allen, Armstrong, and Wolken

Competitive Markets
The individual is accorded special importance within the free enterprise system. As we recognized earlier, we all want to improve the quality of our lives. But this does not mean that we all want the same thing. Quality means different things to different people. For example, some of us like living in the city while others prefer the country. Some people drive sports cars, others drive station wagons. Most farmers prefer pickup trucks.

People do differ. They have varying tastes, preferences, and values. The free enterprise system respects this diversity. This is reflected in the way the “what to produce” question is answered. In a free enterprise system the things produced are the goods and services most highly valued by the individual consumers of that society.

How is this accomplished? It is necessary that each of us has a way to communicate our personal desires. Further, there must be a way for producers of goods to let owners of resources know what they want to operate their factories and manufacturing plants. A communication system is needed that allows the economy to respond to the desires of the people in the society.

In a free enterprise system this communication occurs when buyers and sellers meet in competitive markets. By competitive markets we mean there exists a large number of buyers and sellers where no one is large enough to significantly influence the market price by his actions alone. In other words, the force of competition prevents a single buyer or seller (or group of buyers or sellers) from controlling the market. It is possible for any producer to enter an industry or to leave it if desired. Thus, producers are free to compete for the consumers’ dollars. Similarly, workers are free to compete with each other for jobs, and consumers are free to compete with each other for goods and services. Competitive markets allow us to exercise our freedoms.

In a competitive market, each individual consumer makes his wishes known by casting his dollar votes for those products he values the most. When we buy a Coke, we are telling the Coca Cola Company we like what it is doing for the price it is asking. At the same time, we are telling Coke’s competitors we do not like as well what they are doing for the price they are asking. Those businesses and individuals who produce the goods and services we want at prices we are willing to pay receive our dollar votes. Large vote totals show up as profits, high salaries, or increased wages. Those producing goods and services we do not want at the price they are asking will not receive our votes. These small vote totals show up as reduced profits, losses, lower salaries, or even unemployment. Competitive markets allow each of us the opportunity to influence the variety of goods and services produced.

Competitive markets have a distinct advantage over the voting process in our political system. In an election there can be only one winner — whoever receives the most votes. Our political system can work with only one person holding each elected office. But if this were the case in our economy, we would all be driving a General Motors car. In a free enterprise system, however, General Motors, Ford, American Motors, Chrysler, and a host of imports can all win a share of the market. Competitive markets encourage businesses to produce a wide variety of products from which consumers can make selections. Both businesses and consumers benefit from this arrangement.

Competitive markets, then, channel our scarce resources into the production of goods and services we value highly and away from those of low value. For example, when a business makes a large profit, there is incentive for other individuals to enter that business. On the other hand, if a business is losing money or members of an occupation receive a low wage, there is incentive to enter a different line of business or a different occupation. In this way, resources are guided toward the production of goods and services receiving economic rewards and away from those receiving economic punishments. This is one reason competition is so important.

For a moment, let’s consider a command economy where the markets are not competitive but are, instead, controlled by a planning committee. The planners decide who can enter the market and determine the price (or wage) they will receive. For example, Soviet planners set quotas for each factory and fix the price of the product, eliminating competition. Individual producers are not free to make their own choices.

Compare this with a competitive market. Suppose, for example, McDonald’s is receiving large profits. This creates incentive for others to enter the fast-food business. New businesses do not need a committee’s permission to enter this market, but they must be competitive, or they will not survive. This increases the supply of fast-food service, and keeps prices low and quality high. As a result we have a wide variety of fast-food services from hamburgers, to pizza, to fried chicken. As long as individuals value this service enough to pay the price, producers will continue to provide it.

Competition helps maintain low prices and high quality at the same time. As we try to improve our standard of living, we look for the “best buy” in terms of both price and quality. This encourages producers to produce their products efficiently so they can be sold at competitive prices and still result in profit for the businesses. Efforts to reduce costs by finding better production processes lead to innovation and technological progress. Businesses that don’t keep up with competing firms face lower profits or perhaps losses and eventual failure. While competition serves us by keeping prices low, profits must still be large enough to encourage producers to continue supplying the product. After all, profits are the rewards businesses receive for producing the things we want. If profits are too low, or eliminated entirely, businesses will stop making these products.

Competitive markets protect us in still another way. As long as businesses are free to enter any market, they will do so when opportunities for large rewards are present. This insures a large number of suppliers and employers, which prevents any single firm from exploiting individual consumers and workers. For example, if we are not treated properly at one store or job, we have others to choose from. This prevents the creation of a monopoly which can control a market for its own purposes. If free entry is restricted, competition is reduced, allowing some to benefit at the expense of others. Competitive markets, then, act as a regulatory force within the free enterprise system. Competition results in lower prices and higher quality and protects the consumer and worker from the abuses of monopoly.

The outcome of the decisions made by individuals in competitive markets ultimately determines how the pie is divided among the members of society. The greater the positive rewards we receive for producing valuable goods and services, the larger the slice of pie we can purchase. A free enterprise system rewards those who use limited resources to produce the goods and services that individuals want.

In summary, a free enterprise system responds to the wants and desires of individuals. It allows each of us to make our own value judgments and gives us the opportunity to express our decisions in competitive markets. Both the buyer and seller must feel they will benefit from any given transaction. If they do not, no transaction will take place. In a pure free enterprise system, we, as individuals, answer the questions of “what to produce,” “how to produce,” and “how to divide.”