6 April 2007

The Assumptions of Perfect Competition: Lesson 1

At the heart of the justification of the supremacy of the market system within academic economics lies the theory of perfect competition, so it is high time to carry out a reality check on this theory, which is itself based on a series of assumptions. In this section we will explore and test these assumptions and find that, unsurprisingly, they are as far from reality in the global marketplace as the model of Camelot in the Monty Python film. Others have produced similar critiques, so we may conclude, as do Gaffney and Harrison, that it remains for ideological rather than rational reasons.

It is an old joke in the economics profession that if there is some fact about the real world that makes modelling difficult you deal with this by assuming it away. This technique is used with gay abandon in the case of the theory of perfect competition which is based on a series of fundamental assumptions without which it is assumed not to be valid. The list of assumptions of perfect competition that I critique in this and a few following posts is taken from a book published in 1974, the 2003 edition of a standard economics text (I refer to it from here on simply as ‘Sloman’); but similar ones could be found in any introductory economics text. In fact, a rapid search of the internet will find plenty of examples of university courses teaching approximately the same theory as is critiqued below.

The paucity of change over the past 30 years or so, during which economic conditions have changed beyond all recognition, is evidence of the theory as catechism rather than science. The last time I taught this theory to undergraduates I was issued with a US text. It explained the theory of perfect competition by reference to suppliers of two competitive products: ice cream and frozen yoghurt. This seems to epitomise some of the problems with the theory and with economics in general. First, it clearly originates in a foreign, US culture: how many UK kids have ever tried frozen yoghurt? Secondly, the example is trivialising. I felt embarrassed explaining these issues which influence so many lives (and deaths, in the developing world) in terms of an irrelevant, self-indulgent good such as ice-cream. For many of those who are the victims of the market ideology, ice-cream is a luxury which, although far better suited to their climate than ours, they will never have the pleasure of enjoying.

Assumption 1: Producers aims to maximise their profits . . . and consumers are interested in maximising their utility

At first sight there seems little to take issue with in this first assumption. We might quibble with the use of the word ‘producers’ since, as I discuss in Chapter 7, very few producers are actually able to take their own goods to the market in the capitalist as presently structured. We might also question the idea of ‘utility’. The consumer’s interest in the market transaction is often reduced to that of gaining the maximum amount of the good in question for the minimum amount of money: as the later fourth assumption makes clear, according to economic theory, consumers cannot choose between goods on the basis of quality, since goods are taken to be homogeneous.

Should we be satisfied with this thin description of the market relationship? In reality, our purchasing involves significant psychological and cultural content, and our production and exchange of goods plays a far deeper and more significant part in our human lives that this assumption suggests. Our decisions about purchasing may be based on strong moral or religious commitments, as the growth in the fair trade movement has made clear. Economists may theoretically absorb these concerns by extending their concept of ‘utility’, but frequently they do not, and even if they wish to they are unlikely to succeed in summing up such complex social processes within their desired economic calculus.

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