Posted on by Art Powell

Capitalism is about profits but economic theory tells us price should equal the marginal cost which does not allow for any profit. It could be there is a contradiction between what we say we believe and the way we actually behave. Figuring this out may be a major step in understanding our economy.

Price should equal marginal cost, the cost of the last item produced, because profits will attract more producers into an industry until competition forces prices down to the marginal cost level. For this theory to work there must be perfect competition. Perfect competition requires easy entry into a business, a uniform product, that no participant in the market be large enough to influence prices by limiting sales or purchases and that all participants in the market have full knowledge of the market.

In perfect competition there are no profits because competition will force prices down to breakeven point.

This would be great for customers but producers, believing they have a right to profits want to restrict competition. As producers tend to have more power than consumers there are in our economy lots of restrictions on competition. There are many ways to restrict competition but probably the best is to get governments to pass legislation that interferes with the operation of a competitive market. Look at the four requirements for perfect competition in the second paragraph above for ideas how to restrict competition. Some of the legislation which interferes is patent and copyright, tariffs, subsidies and licensing.

An advantage of legislation restricting competition is that the state and its legal system can be used to enforce it.

Sometimes definitions can be fuzzy and most definitions of capitalism fit this. The definition of perfect competition (see second paragraph above) is more precise even if it appears unrealistic. We have jokes about economists making assumptions. It is not safe to assume that capitalism is perfect competition.

I think the perfect competition model is very useful in that it provides an ideal towards which we could be working. It provides guidance for policy even though there are lots of forces working against that policy.

Whatever name we apply to our way of organizing our economy, it is important to understand that it is based on governments passing legislation to restrict competition.

If you liked this post your are invited to comment, press the like button and/or click one of the share buttons. If you disagree you are invited to say why in a comment. While I like the idea of sharing this platform, my personality is such that I don’t reply to many comments.

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Filed under: Economics | Tagged: capitalism, Competition, economic theory, Economics, legislation, marginal cost, Perfect competition, profits |