Understanding competition in different market structures.

There seems to be some surprise when different forms of competition are used in different industries and markets; however, much of this confusion can be remedied if we break the system into an array of three basic market structures and the likely competitive behavior of each.

For example, here in Florida our legislature passed a law allowing a particular form of medical marijuana, dubbed Charlotte’s Web (a non-hallucinogenic form of cannabis), to be used for the treatment of different chronic conditions. Unfortunately, in the drafting of the bill, the legislature did what government does and decided the market for this product would be best regulated by government than by market participants and consumers. This did prevent any lives from being lost to misuse of the drug, but also ensured no lives could be saved either because, after almost a year, the production of the substance has been exactly zero.   This is because the supply side has been embroiled in legal suits over who will get to produce and profit off of this new product; or, more succinctly, who will the government choose to hold monopolies over the consumer?

This circumstance prompted some to accuse the potential producers to be engaging in “greedy behavior.” Question is: is this true? No, it is most certainly false. In fact, anyone with a rudimentary understanding of economics could have predicted this very result. Instead, the problem was with the premise that government should regulate to best ensure consumer safety. Regulation has, as a matter of fact, been most successful at preventing consumer access to products, not ensuring safety (see airline deregulation).

For the sake of simplicity I will break down the market into three types: 1) free market, 2) government regulated market, and 3) black markets (where the products are illegal for sale and/or use). Within these three market types there are very predictable methods for competition between suppliers. You see, no matter the structure of the market, there is competition for market share (portion of the available consumers); it is the market structure which dictates the methods employed to compete for customers not the production side participants.

In a free market, producers are required to appeal to the consumer to sell their products; this is most commonly done through pricing and quality; although an argument could be made for the influence of advertising and endorsements in the modern market. Either way, the transaction is voluntary on both sides—the producer provides a certain good at a certain price and consumers choose from whom (and what) they will buy.

On the opposite end of the spectrum we have black markets; markets that are required to operate outside of the law and at greater risk than a traditional legal market. These markets still exist because the demand for certain illegal products exists and; with greater risk, higher levels of profits can be extracted from the consumers. Once the ratio between risk and profits become acceptable, people will enter into the market; however, it is those people with higher risk tolerance that will be induced into the market earliest.

This reality dictates that people already comfortable with high levels of risk will enter these markets. Thus, competition will take place in a very risky manner. Instead of these market participants competing with price and quality, they will instead compete with violence and intimidation. We can see this clearly illustrated in the prohibition era alcohol trade and the modern day drug trade. The contrast between those two examples also highlights how that status quo of violence ends when the legal prohibition ends; the drug trade still involves high levels of crime while alcohol involves practically none.

Finally, in a regulated market there is also competition between suppliers (and potential suppliers). This competition, however, does not take place for the benefit of the consumers; very little appeal is made to them. On the contrary, this competition takes place in the legislature and in the court room. When government determines market eligibility, the consumers are not a requisite piece of the equation; no longer is the preference of the consumers the primary concern. Bureaucrats, politicians, lobbyists, and judges become the arbiters of market share. This leads to inefficiency, cronyism, and a lack of innovation. If you have a government mandated monopoly on the distribution of a product, what is the motivation to make that product better or less expensive? There is none. Competitors are either not allowed or the obstacles to entry are so great that the likelihood of a new competitor entering is close to zero.

This is the problem with the Charlotte’s Web law. Because competition is not based on price and quality, potential suppliers must compete in the legislature or in the court room. Once these suppliers are chosen by government (and given regulatory power by their inclusion into a regulatory board) I can guarantee that it is unlikely the regulatory nature of the market for Charlotte’s Web will change. Also, we can expect supply to be relatively low, while price is disproportionately high compared to cost and value. A regulatory monopoly (or oligopoly in the case of multiple firms) is no less predatory on consumers than a natural monopoly; they just get to rest well knowing they are immune to challenge from a government that instituted the monopoly in the first place. Consumers (in this case, sick children and their families) are caught in the cooperative crossfire that exists between the suppliers and government.

 

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