The Legend of Perfect Competition | Cash Course | PragerU

My son. Yes, father. It's time we had the talk. About what, father? War? Love? No, no. Economics. I've traveled many lands, and I have seen that no economy is perfect. All economies involve competition. Those who make goods and services compete for everyone's hard-earned coin. Some kingdoms make this competition more difficult, while others let it run wild and free like a river. But there are men who speak of a legend. The legend of perfect competition. It is a realm where goods are plentiful, of the highest craft and quality. And all the while, prices remain low. But, father, is such a place possible? For it to be. The legend says that four forces must align perfectly. First, we begin with a very large number of firms. Firms refer to companies or businesses that sell goods or services. In a perfect economy, many firms compete for the consumer's attention and money. Whether the product is saddles, iron skillets, or horses. More firms mean more choices. Where there's stiff competition, there's a rush to make what consumers most demand and sell it at the lowest price possible. If consumers don't like what one firm is offering, they can just move on to the next one. Just like a princess moving on to the next prince. Exactly. I courted a princess once. Really, father? The next force is standardized products. In perfect competition, consumers choose products that are basically the same, no matter who offers them. If you buy a turkey leg at Old Jackson's Tavern, it's no different than buying it at McDuff's. Candles, turnips, or hats, no different. When products are the same, consumers can trust that any given one will have the same features as another. And if each product is a perfect substitute for another, then it all comes down to price. Clever boy. Standardized products lead us to the third force. Firms as price takers. This means the market determines the price customers will pay, not the firms themselves. Ponder this. If all products are standardized, and the consumer's decision comes down to price, any firm selling at a higher price than others won't be around for long. This leaves producers one option. Be a price taker, or... Go home empty-handed. If customers buy turkey legs from Old Jackson's at one price, they won't accept a higher price from O'Malley's, McDuff's, McSanchez, or McMahon's. Yes, yes. But doesn't this mean that some firms won't survive? It does. Which brings us to the last force. No barriers to entry or exit. In a perfectly competitive market, firms can enter or leave it without hassle. If a young apprentice wants to open his own blacksmith shop and forge iron skillets, there's no lord or king stopping him. And there's no government giving other blacksmiths an unfair advantage. If that blacksmith wants to close up shop, it's just as easy. Firms can jump in or out of the market with few hurdles or penalties. Freedom to enter or leave the economy keeps prices low and products plentiful. What a place! A place but a dream, isn't it, Father? Yes, son. A mere dream that stirs the imaginations of men. But in the real world, even in free market economies, these four forces never line up to meet those perfect conditions. For example, you could have many firms selling turkey legs, but they may not be perfect substitutes. Sellers could offer different kinds. Maybe McDuff's is juicier. McMahon's is leaner. Different prices that give consumers more distinct choices. And for many products, there's usually some barrier to entry or exit due to the cost. A blacksmith shop requires a lot of time and money to start, not to mention the training of skilled workers. Once it's up and running and it becomes more efficient and productive, stopping can be just as costly as starting. And of course, governments are almost always involved in an economy, picking winners and losers by supporting certain industries, businesses, and even specific products. When it comes to large infrastructure projects, like roads or forts, there are very few firms that can offer them due to their size and scale. So does the legend matter, Father? Of course. It's helpful for understanding how an economy could work when it's most efficient. Life is not perfect, and markets are no different. But the legend reminds us that the more competition, the better. For kings and for ordinary folk alike. Do you hear that, Father? Time for our own competition. Perfect! Watch more at PragerUKids.com And parents, don't forget to subscribe.