"Wasteful" Competition

The Economist has run a few articles recently about "involution" in the Chinese economy, which is a concern that companies in some key markets (e.g. electric vehicles) are competing too hard. I disagree!

What the market should look like. Credit: Crazyjungle@wikibooks

I decided to write a letter to the Economist editorial board. Here it is:

Dear Economist Editorial Team,

In several recent articles, you discussed the dangers of "involution" in the Chinese economy, where "companies are cutting prices to poach customers, forcing rivals to do the same, which leaves everyone’s profits lower and no one’s market share higher." (Leader, August 28) Isn't that what's supposed to happen in a competitive economy? I'm concerned that we've become so inured to monopolies and oligopolies that even The Economist would fear competition that forces marginal revenue to equal marginal cost.

-Adam Probst
Chagrin Falls, Ohio, USA

Some additional thoughts

I kept the letter short based on what I've seen published from previous letters. I'll expand further here. In "perfect competition" in microeconomics, any given company in a market sees a "flat" demand curve: the company is small enough that the market will absorb as much product as the company can produce: no matter how few widgets that one company sells, enough other widget-sellers exist that prices won't go up due to scarcity. Similarly, no matter how many widgets the company produces, it will never be able to flood the market and drive prices down.

The market price is then set by how many companies are in the market (total supply) and total demand from consumers. When the total quantity supplied at a given price equals the total quantity demanded at that price, the market reaches equilibrium and that price becomes the "market price". Every company produces at "marginal cost = marginal revenue": they sell as many widgets as they can up to the point where the cost of producing the last widget just breaks even. Any additional production means they'll lose money (too much overtime pay, factory expansion too expensive, organization becomes dysfunctional, etc.), so marginal revenue (i.e. the sales price) = marginal cost. We should expect companies in a competitive market to make a small profit and no more!

My reference to "monopolies and oligopolies" means that in situations other than perfect competition, companies don't see the same flat demand as in perfect competition. Instead they see downward-sloping demand because they can move market prices based on how much they produce. If the monopolist (only producer of a widget) or oligopolist (one of very few producers) cuts their production, prices go up because of shortages. If they over-produce, they can flood the market and drive prices down. Because of this "market power", monopolistic or oligopolistic markets tend to see lower quantities and higher prices than under perfect competition because the companies produce at the lower profit-maximizing quantity, not where marginal cost = marginal revenue.

My concern is that we've become so used to huge companies with market power making huge profits, we are no longer seeing competitive markets as healthy markets! And that's why I wrote the letter.