Post-Keynesian and Austrian criticisms - Essay Example

The Neoclassical perspective of competition narrates the determination of prices, output and income distributions in markets via equality of supply and demand. This theory is based on three fundamental assumptions: 1. People have rational preferences defined over all variables that can be identified and associated with a value. Rationality in this context refers to the fact that each agent’s objective to operate in self-interest and maximize their individual benefits. This naturally leads on to the next assumption.

Based on these assumptions, neoclassical theory of competition essentially is a doctrine that postulates the allocation of scare resources by firms to maximise profit which in turn, leads to a wide range of economic activity. Equilibrium is the result of individual optimization procedures. Utility maximization by consumers provides individual demand functions or correspondences which can be aggregated under certain assumptions to form the market demand function. Similarly, the market supply function is obtained from the optimization exercise by firms.

The equality of these identifies the set of prices and quantities that are optima for producers and consumers alike and this is the competitive equilibrium. It should be convenient for future reference to note here that profit maximization requires a firm’s marginal cost is equal to its marginal revenue (MC=MR) since this corresponds to the maximum point on the total profit curve. Under perfect competition there are a very large number of firms in the market, each selling an identical product.

Consequently, each firm caters only to an insignificant share of the market and is thus only a price taker. The profit maximization leads to P=MR=MC. There can be supernormal or positive profits only in the short run. In the long run, there is free entry and as a result, only zero profits can be sustained. In contrast, the monopolist can make positive profits both in the long run as well as the short