Competitive Vices

In markets, firms must compete following a set of rules determined by laws, regulations, and social practices or pressures. This article investigates the effect of the degree of competition on the extent to which firms invest in behaving according to the rules of the marketplace. The authors model investments in following these rules as increasing the firm's marginal costs of production and decreasing its probability of being caught violating the market rules (and thus losing profits). They show that greater competition leads to smaller investments in following the market rules. This leads to (1) the existence of a social optimum degree of competition that is less than perfect competition and (2) more competition in general, thus prompting greater optimal monitoring efforts. Stricter market rules can lead to greater investments in satisfying the market rules and to lower production. The authors also present results on the likelihood of firms having broken the market rules depending on relative market shares, optimal monitoring, and the effect of dynamics on the incentives to satisfy the market rules.