Post-Keynesian and Austrian Criticisms of the Standard Neoclassical View of Competition - Coursework Example

Assess the significance of Post-Keynesian and Austrian criticisms of the standard neo ical view of competition Neo ical economists often think about the classical theorists to be the initiators of neoclassical general competitive evaluation. Competition according to Adam Smith implies free competition. That is to say, everybody should take action according to his or her self-interests. There should be no obstacles to economic actions. The market is the place where people and their interests are synchronized and disturbances are eradicated. The fundamental system that creates a resourceful allocation of resources is the demand and supply method. In addition, this mechanism is believed to be the only economic organization that can ensure freedom, parity and fairness for the people. Neoclassical writers lengthened this feature of Smith’s hypothesis of a market structure by devising numerous conditions under which efficient resource distribution and an optimal level of social welfare would be appreciated. The key conditions required for a perfectly competitive market structure are observed as: profit maximizing manufacturers and utility maximizing customers; an adequately large number of market representatives; no externalities among their activities; perfect mobility of resources between industries; and perfect insight. Given these prerequisites the competitive process ensures that prices converge towards equilibrium prices. This permits an ongoing exchange of products between market contestants. Not only is the existence of equilibrium prices guaranteed by the market structure, but the removal of disturbances and an optimum allocation of resources is caused by competition. These traits of the standard neoclassical view of competition necessitate some criteria. First, this hypothesis of competition can be observed as a ‘quantity theory of competition’. The strength of competition in the market, for instance, among producers, is calculated by the number of firms in the industry. It is assumed that the larger number of firms will lead to the optimal level of results. Secondly, an essential and key assumption is that prices and quantities converge towards an equilibrium determined by competitive forces. Price and quantity interaction will remove disequilibria between demand and supply. The exogenous alterations of the market systems will disappear over time. An alteration in the method used by manufacturers and an alteration in their structure will, following a short adjustment time, bring about a new competitive equilibrium. Equilibrium will not be caused by an aggressive equalization of disequilibria, but is an effect of a constant and smooth procedure of convergence. A third feature of the neoclassical analysis is the elimination of uncertainty, risk and anticipation - all aspects which are very significant factors in the capitalist form of production. While these idealized market forms are believed as preconditions for perfect competition and the accomplishment of a social welfare optimum, deviations can accordingly be regarded as leading to ‘imperfect’, ‘restricted’ or ‘monopolistic’ competition. Deviations are brought about by (1) industrial concentration which permits a greater allocation of the market for top firms, (2) coalitions, agreements and collusion among contestants in the market, and (3) a restricted mobility of resources between various industries (market entry and exit barricades). All three aspects let principal firms manipulate prices and quantities by holding back production and increasing prices. Therefore once the hypothesis of perfect competition is accepted, the concepts of monopoly and oligopoly power are established in advance by the theory and treated as an incongruity. Divergence from competitive prices and the continuation of differential profit rates are subsequently left to be explained by a hypothesis of ‘imperfect competition’ (Semmler, n.d., pp. 92-95). The Austrian work varies in character and substance from a good deal of neoclassical theory, which, in spite of extensive and increasing awareness of its restrictions, continues to serve as the critical core of mainstream economics. Markets comprise of effectively maximizing representatives whose decisions are held to cope with in a perfect manner. Each maximizing decision correctly expects all other maximizing decisions, which are made at the same time. For this condition to be satisfied, only that set of input and output prices and quantities can exist which all together fulfils the appropriate equations of demand and supply. It is this feature of modern neoclassical economics which justifies its characteristic importance upon: (a) the constrained maximization pattern inflicted by the hypothesis upon individual decision-making, and (b) the mathematics of simultaneous equation systems. Intrepid efforts have been made to improve the pragmatism of these equilibrium microeconomic models by establishing assumptions to accept imperfections in competition. Neoclassical economics operates on the supposition that the world reveals the associations that would prevail in the model of competitive equilibrium. Whilst Austrians are not the only one to condemn this strategy to understanding markets, their disapprovals have been both ground-breaking and incisive. Austrian disappointment with this standard approach to understanding actual world market phenomena appeared most clearly in the 40’s (Kirzner, 1997, p. 63). Contemporary presentations of the entrepreneurial discovery strategy have repeated these condemnations of equilibrium economics, and have organized these criticisms in seeking to downgrade the idea of perfect competition from its position of supremacy in contemporary neoclassical theory. It has been done so as to replace it by ideas of dynamic competition (in which market contestants are, in place of absolutely price takers, competitive price-and quality-makers). Within the two extensive bases for Austrian criticism, numerous strands of intricacy with the neoclassical competitive equilibrium example may be differentiated. The clear classification of these strands will assist us to recognize the Austrian nature of the optimistic approach. This approach is based on entrepreneurial discovery condemnations of the unrealistic nature of neoclassical theory. This recounts both the way in which individual decisions are formed in that theory and the way in which that hypothesis considers real world market results as fulfilling the conditions for equilibrium. At the micro level, Austrians have considered sharp exclusion to the manner in which neoclassical theory has depicted the individual decision as an automatic exercise in constrained maximization. Such a depiction steals away the decision making power from the humans in which imagination and audacity must inexorably play vital roles. In case of neoclassical theory the only way human preference can be rendered analytically to build up a model, which is not made in an open-ended style, and there is no possibility for qualities such as imagination and audacity. In the neoclassical world, decision makers are acquainted with their ignorance. However, in case of Austrians, to abstract from these characters of imagination, audacity, and astonishment, one needs to denature human choice completely (Kirzner, 1997, p. 64). At the market level, Austrians have revolted against microeconomics which can find consistency in markets and can clarify market phenomena only by declaring that markets are, always, to be treated as if already in the achieved appropriate state of equilibrium. Austrians find such an image of the world to be purely false. It is not merely in the sense that an explanatory theoretical model may not present a photographic illustration of the richly complex reality. It is due to the fact that this portrait wrongly labels significant features of realism. For Austrians it is intolerable to claim that, at each and every moment, the pattern of production and consumption decisions presently made is one, which could not probably have been improved upon. In order to claim this, all possibly relevant available opportunities need to be grasped at a given time period, despite knowing about real world economic systems. It is one thing to assume swift equilibrating procedures to impose systematic order upon markets. Another assumption includes treating the world already in the accomplished state of equilibrium (Kirzner, 1997, p. 65). Kenneth Arrow identified that the very idea of a perfectly competitive market in disequilibria is illogical. And he distinguished an obligation to present a model that might justify the appearance, out of primary disequilibria, of an equilibrating procedure. His critique of the core of neo-classicism, exemplifies the susceptibility of mainstream hypothesis to the Austrian condemnations. Entrepreneurial action has no position at all in neoclassical equilibrium microeconomics. However, Austrians the entrepreneurial role offers the theoretical key to explain the market as a procedure (Kirzner, 1997, p. 67; Waterson, 1984, p.11). The Austrian approach incorporates an idea of competition, which varies considerably from that summarized in the label ‘competitive’ as applied in modern neoclassical theory. For neoclassical economics the maximum possible level of competition is symbolized by the equilibrium concept of perfect competition, in which all evidences of competition are absent. For the contemporary Austrian approach, the insight of competition as the dynamic, motivating force for innovation in the market procedure has become vital. The key to a clarification of the equilibrating procedure is to identify the key role of dynamic competition in that procedure. This equilibrating procedure of competition is at work even in markets in which one firm may benefit from monopolistic opportunity. This is due to the fact that even a monopolistic equilibrium can be considered, in a world of improbability, only through a procedure whereby market contestants can become conscious of one another’s thoughts and plans. Only the procedure of competition can attain this. In standard neoclassical equilibrium hypothesis there is no role for the entrepreneur. In equilibrium there is no possibility for pure profit: there is basically nothing for the industrialist to do. The entrepreneur might grab on to the opportunity for business profit generated by provisional nonexistence of full adjustment between input and output markets. Hence the neoclassical market in full equilibrium can find no space for him. In Austrian hypothesis the entrepreneur is a representative whose character has been cautiously explored. By freeing microeconomic evaluation from the restrictions of the equilibrium state, Austrian theory is capable of identifying the speculative component in all individual decision-making, and to include the action of the real world businessman into a theoretical structure that offers understanding of the market procedure (Kirzner, 1997, p. 69-70). Austrian emphasis on the entrepreneur is essential. While each neoclassical decision maker functions in a world of known price and output data, the Austrian industrialist functions to alter price or output data. In the neoclassical situation, a decision can never be corrected since no decision can ever be really mistaken. The reason for an alteration in a decision thus can be established only in an exogenously produced change in the appropriate decision-framework. However, in the Austrian perspective, a decision can be rectified on account of the decision-maker’s detection of a previous error in his outlook of the world (Kirzner, 1997, p. 71). In perfect competition, where each vendor or purchaser has no authority on market prices, there is no longer a space for individual competition, and forces causing expansion in industry are absent. The difficulty is to bring together the theory of the market and that of the individual firm (Carlton and Perloff, 2000, p. 57). Alfred Marshall indicated that external economies might well be met in practice depending on the extensive-ranging features of an industry and the surroundings of the industry, such as, the localization of an industry. However, his assessment of external economies created an added problem, as he considered that internal economies of scale were at least as significant as external economies. In the presence of internal economies of scale the expansion of an industry would be advantageous to largest firms, creating monopolies, and in result altering the competitive powers within such an industry (Schönerwald da Silva, n.d., p. 42-43; Tirole, 1989, p. 35; Scherer and Ross, 1990, p. 267). Post-Keynesian authors began decoding the system of the mainstream microeconomics through a careful evaluation of the theory of perfect competition since they were discontented with Marshall’s confrontation to run off that hypothesis. Sraffa made the first contribution in 1926. He viewed that perfect competition is typified by systematized exchange and homogeneity of the commodities. Additionally, in a perfectly competitive market, the demand is vertical (infinitely elastic) since at all times the marginal cost of production is, in equilibrium, equal to the price. In 1934, Post-Keynesian economists like Joan Violet Robinson asserted that perfect competition, in mainstream economics, entails coherent behavior on the part of purchasers and sellers, complete knowledge, absence of frictions, static conditions, perfect mobility and perfect divisibility of factors of production. Nevertheless, she describes perfect competition in a manner that grips all the suppositions previously exposed, so perfect competition denotes a situation in which the demand for the production of an individual seller is perfectly elastic. In the model of laissez-faire, the law of diminishing returns played a vital role to comprehend the problem of rent, so increasing the utilization of less fertile lands have a propensity to decrease the marginal returns per unit of input. Sraffa concluded that if perfect competition prevails, then the product can be thought to be a homogenous product and this idea is likely to set up the role of diminishing returns. Mainstream economics presupposes diminishing returns as they assume that the economy has innumerous small firms that face homogeneous commodities and inadequate power over the industry supply. However, post-Keynesian economists think commodities to be including properties rather than just agricultural commodities (Schönerwald da Silva, n.d., p. 43-44; Lipczynski, Wilson and Goddard, 2005; Hay and Morris, 1991). They consider product as a collection of varied articles, varying from foodstuff to ironware. Consequently, they developed the notion of product differentiation to comprehend the power of the industry supply by a single firm and there might be the situation for increasing returns of scale and, consequently, imperfect competition. In 1935, one of the post-Keynesian economists, Nicholas Kaldor revealed the role of perfect divisibility supposed by mainstream economics to encourage the hypothesis of perfect competition. He identified that when mainstream economics presupposes perfect divisibility and, by definition, economies of scale are absolutely absent, perfect competition will be instituted owing to the independence of the market forces. According to Sraffa, mainstream economics does not elucidate the role of increasing returns since it does enlighten the role of diminishing returns. The structure narrates increasing returns to the division of labor. It did not build up the role of increasing returns as being a method that takes place when the dimension of the firm increases. In a different way, mainstream economics truly believes that internal division of labor supports the modification. Thus, it takes place only in the local framework of the firms. The significance of external economies was increasingly highlighted as a benefit derived by individual manufacturers from the expansion, not of their own individual responsibility, but of the industry in its aggregate. In mainstream economics, firms are likely to have their plants built up on a scale which (considering the technical concerns and the supply price) is capable of producing most economically. However, post-Keynesian economists assert that plants and firms may be interconnected or a firm may incorporate a number of plants, or a number of firms make use of a single plant. Thus, resources of production in perfect competition cannot be dependent on the optimal size of the state of demand. It follows that no augmentation of output will provide a substantial manipulation on price. The firm is free to increase its plant to the scale at which it can manufacture most reasonably (Schönerwald da Silva, n.d., p. 44; Davies and Lyons, 1989). One of the eminent post-Keynesian economists, Michael Kalecki invented the principle of effective demand. According to his hypothesis of price, investment and distribution, money and finance is considered to be better than Keynes’ General Theory. Kalecki’s hypothesis made ‘imperfect competition’ identical with a lack of effectual demand for capitalist economies. However, his general analysis is pertinent to theoretical ‘free competition’ structure (Davidson, 2002, p. 631). In general, the entrepreneur has the indistinct idea about the actual elasticity of demand for his commodity in terms of the ratio of his price to the average price. Thus, there is no exact association between the actual demand functions and pricing equations. Kalecki evaluated the case of ‘pure imperfect competition’ as the case of general theory rather than his main interest (Basile and Salvadori, 1994, pp. 435-436). Thus, Post-Keynesian economists asserted that every plant is erected on a scale which is lower than the best possible one. Subsequently, the long-run average cost (LAC) can decline and bring about a state of increasing returns. These conditions were not evidently stated in the conventional microeconomic theory. The post-Keynesian school has been recognized by its constant criticism of the hypothesis of perfect competition, so the criticism supported the origin of the theory of imperfect competition. Economists in the Austrian approach have tended tremendously to favor market solutions for working out society’s economic issues. They have pointed out the standard neoclassical economics have failed to provide a satisfying theoretical background on the market economies. References: 1. Kirzner, I.M, March 1997. “Entrepreneurial Discovery and the Competitive Market Process: An Austrian Approach”. Journal of Economic Literature Vol. XXXV, pp. 60-85. 2. Semmler, W, n.d. “Theories of Competition and Monopoly”. 3. Carlton, D.W, Perloff, J.M, 2000. Modern industrial organization. Addison-Wesley series in economics. Addison-Wesley (London). 4. Davies, S, Lyons, B, 1989. Economics of industrial organization. Longman (New York). 5. Hay, D.A, Morris, D, 1991. Industrial economics: theory and evidence. Oxford University Press (Oxford). 6. Lipczynski, J, Wilson, J, Goddard, J, 2005. Industrial Organization: Competition, Strategy, Policy. Pearson Education (London). 7. Scherer, F, Ross, D, 1990. Industrial market structure and economic performance. Houghton Mifflin (Massachusetts). 8. Tirole, J, 1989. The theory of industrial organization. MIT Press (Massachusetts). 9. Waterson, M, 1984. Economic theory of the industry. CUP Archive (Cambridge). 10. Schönerwald da Silva, C.E, n.d. “The theory of the imperfect competition: A review of the post-Keynesian contribution”. Available at: http://revistaseletronicas.pucrs.br/face/ojs/index.php/face/article/viewFile/2674/2037 (Accessed on Dec. 28, 2009). 11. Davidson, P, 2002. “Keynes vs. Kalecki: responses to Lopez and Kriesler”. Journal of Post-Keynesian Economics. Vol. 24, No. 4. 12. Basile, L, Salvadori, N, 1994. “On the existence of a solution to Kalecki’s pricing equations”. Journal of Post-Keynesian Economics. Vol. 16, No. 3. Available at: http://www-dse.ec.unipi.it/persone/docenti/salvadori/pdf/Carson_JPKE.pdf (Accessed on Dec. 29, 2009). Read More