ECON 356 - Outline Fourteen

Remember (a note of caution):  Not everyone agrees on how to "do" social science.  What is the right or wrong way is up to you to decide.  But what that means is that in order to do that you must do your best to understand ALL of the different arguments - otherwise you are agreeing or disagreeing with something that you don't understand - which does not make sense!!  So just because I disagree with the mainstream method does not mean it is not worth learning -- in my opinion, all of the theories are worth learning.

The Critics of the Mainstream Theory of Competition and Monopoly

1. The Non-Economists (sociologists, anthropologists ,etc.) :

Markets are not as perfect as the model predicts.  The perfect knowledge assumption regarding economic actors is bogus.

    However, the solution is often:  Government planning must be better than markets.  But this assumes that planners have the knowledge of what is "best" for society.

     We can also find this same knowledge issue within economics.  Keynesian economists talk about the knowledge that economic actors don't have but basically assume that government planners (intellectuals) have the knowledge to plan an economy.

    Efficiency standard also criticized: 

The claim - economists always think that economic efficiency (allocative and productive) is the end-all result that should be strived for -- at the expense of justice, for example ("efficiency vs. equity") or at the expense of environmental issues.

    However, certainly the mainstream model is claiming that a monopolist, for example, isn't "just" -- so there is a standard of justice in the model.  There is a value judgement.

Not just because he makes "too much money" - (he is not marginal cost pricing) -

So maybe the two aren't so different after all?

But usually the claim is:  "all you care about is making money (monetary profit) -- and the most efficient way possible no matter who gets hurt."  The assumption being that making a monetary profit in markets hurts some people so others can gain.  Is that true?  What do you think?

Side Note:  Supporters of the model of perfect competition (as Hayek points out in your reading) also (usually) want government planning - but note the difference here - their government is one that is trying to force the real world to look like the model of perfect competition.  Forced standardization, for example.  Antitrust laws, for example.

2.  Marxists:  The major disagreement here is in the "nature of man."  Mainstream economists do assume that man acts rationally, he chooses (under assumed constraints) in a free choice situation.  His "nature" is to be self interested.

    Marx, on the other hand, said that the economic system in which a person lives to a great extent determines the choices people make.  There are a lot of "power" structures within a market economy that take choices away from people.  Labor, for example, cannot choose the wage he or she works for -- they are at the whim of the power that the employer has.

    Therefore the main critique here is the mainstream theory assumes that people act in their self interest and that profit maximizing (moving resources to their highest valued use) is a good thing.  It benefits everyone.  But if people really aren't making "free choices" regarding resource allocation -- but instead are "forced" to buy a blue car because of advertising, for example, then the allocation of resources within markets is not a good thing.

    Of course, this always begs the question:  then where should resources be allocated?  Who knows?  How have the Marxists escaped the wrath of the power structure within markets - able to rise above and know when people are making bad choices about resources?

There's a lot more to Marxism than this critique, but I think this is the big one.

3.  Austrian or process economists:

    Main problem - Method:  Having to conform a theory to a method (math model for example - in this case and others) leads one to completely miss the problem at hand! 

So what is the problem then?  Hayek says it is, "The economic problem is a problem of making the best use of what resources we have, and not one of what we should do if the situation were different from what it actually is."

And , "The real problem in all this is not whether we will get given commodities or services at given marginal costs but mainly by what commodities and services the needs of the people can be most cheaply satisfied."

So the main methodological differences are:

1.  Methodological individualism:

            Macroeconomics is a mainstream concept (aggregates).  See paragraph quoted on p. 12 of Elgar reading.

2.  Subjectivism:

            See Elgar reading p. 17, "This is the fundamental . . . "

            Also p. 19, the paragraph that starts with, 'In the calculation debate, . . . "

3.  Process vs. End States:

            "Radical ignorance" -

            The role of the entrepreneur:

            See Elgar reading p. 25, the paragraph that starts with, "Equilibrium-based criteria are . . . "

So in particular - let's look at the mainstream model of perfect competition and monopoly:

So from your reading, "Competition as a Discovery Procedure, " ...'perfect competition' ... leaves no room whatever for the activity called competition, which is presumed to have already done its task."  In other words, we are at an equilibrium, with no real discussion of how we got there.

More fundamentally, the real economic problem deals with the human condition -- what allows people to survive?  To thrive?  To be happy?

Note under the model of perfect competition "perfect" is defined:  allocative and productive efficiency.

Why do you think that situation is defined as "perfect?"

Least cost.

Best allocation of resources.

Aren't those what economist's study? 

Let's come back to this later.....

First let's look at the difference between the mainstream model and the Austrian or process theory with respect to different topics:

a.  Definition of competition:

Hayek in  "Competition as a Discovery Procedure" says this, " . . whenever the use of competition can be rationally justified, it is on the ground that we do not know in advance the facts that determine the actions of competitors.  In sports or in examinations, no less than in the award of government contracts or of prizes for poetry, it would clearly be pointless to arrange for competition, if we were certain beforehand who would do best.  As indicated in the title of this lecture, I propose to consider competition as a procedure for the discovery of such facts as, without resort to it, would not be known to anyone, or at least would not be utilized."

So in defining competition as a discovery procedure, interesting consequences can be observed that are not really obvious otherwise:

1.  "... competition is valuable only because, and so far as, its results are unpredictable and on the whole different from those which anyone has, or could have, deliberately aimed at."

2.  "... the generally beneficial effects of competition must include disappointing or defeating some particular expectations or intentions."

3.  "If we do not know the facts we hope to discover by means of competition, we can never ascertain how effective it has been in discovering those facts that might be discovered."   Or, "The necessary consequence of the reason why we use competition is that, in those cases in which it is interesting, the validity of the theory can never be tested empirically."

But - we can perhaps compare a world without competition, with a world with it....

4.  "... the benefits of particular facts, whose usefulness competition in the market discovers, are in a great measure transitory...... [the theory] does not predict particular results the market will achieve." 

Therefore -- things change, what works changes, we can't say that in every case such and such will work.

5.  "This, in the nature of the case, the theory of competition cannot do in any situation in which it is sensible to employ it. . . ., its capacity to predict is necessarily limited to predicting the kind of pattern, or the abstract character of the order that will form itself, but does not extend to the prediction of particular facts." 

For example -- does not predict the structure of an industry, or exact market prices and costs.  It does predict, however, that generally, with competition, there will be more innovation, more choice, etc. than would exist without competition.  Any particular kind of innovation cannot be predicted.

So what about the Structure - Conduct - Performance theory?

Note that the structure of the industry is only important if it in some way impedes the discovery process (which most likely will not happen without legal barriers to entry).

Basically - the structure comes out of competition (conduct) and the performance (NOT defined as allocative and productive efficiency) is a feedback mechanism to those who are acting in the market:

Efficiency here - defined as what the individual thinks (subjective) is his/her opportunity cost -- am I making enough to stay in this business (monetary and/or non-monetary profit or benefits - this could include a moral component to what you are doing).   Much broader (subjective) definition of "efficiency."

b.  The Concept of Monopoly:

Note Hayek's references to this in The Meaning of Competition, "A person who possesses the exclusive knowledge or skill which enables him to reduce the cost of production of a commodity by 50 per cent still renders an enormous service to society if he enters its production and reduces its price by only 25 per cent - not only through that price reduction but also through his additional savings of cost. But it is only through competition that we can assume that these possible savings of cost will be achieved.  Even if in each instance prices were only just low enough to keep out producers which do not enjoy these or other equivalent advantages, so that each commodity were produced as cheaply as possible, though many may be sold at prices considerably above cost, this would probably be a result which could not be achieved by any other method than that of letting competition operate." (my bold)

What the model of perfect competition considers "monopoly power" (downward sloping demand curve, pricing above MC), Hayek considers beneficial -- because the viable or realistic alternative is not P = MC, it is not having the lower price and new (better, different) product at all without competition.  A downward sloping demand curve is the norm -- it is NOT monopolistic in any sense.

We do not "beforehand" know what works and does not work -- that's the key.

Also from The Meaning of Competition, "This is, however, only one of the many points on which the neglect of the time element  makes the theoretical picture of perfect competition so entirely remote from all that is relevant to an understanding of the process of competition." 

Notice the mention of the "time element" - what does Hayek mean by this?

This relates to his discussion on how quickly (or slowly) "adaptation" takes place in a market.  Look at the grain market vs. the oil (or energy) market.

Hayek - It is only in a market where adaptation is slow compared with the rate of change that the process of competition is in continuous operation.  And though the reason why adaptation is slow may be that competition is weak, e.g., because there are special obstacles to entry into the trade, or because of some other factors of the character of natural monopoly, slow adaptation does by no means necessarily mean weak competition."

He basically describes the oil (energy) market.  Conclusion:  competition will eventually discover alternatives if that's what people want -- this knowledge is complex and not easy to discover (not only technical) -- but what it is that people really want.

That's why, when an issue becomes so politicized and propaganda is everywhere -- it makes it more difficult for good knowledge to be discovered and utilized (good = real, the truth).

So in conclusion:

A "monopoly price" does not exist -- there are only market prices agreed upon in a trade.

Exception:  legal barriers - Hayek mentions this in The Meaning of Competition , "In such a situation how would conditions differ, if competition were "free" in the traditional sense, from those which would exist if, for example, only people licensed by authority, or both?  Clearly there would be not only no likelihood that the different things would be produced by those who knew best how to do it and therefore could do it at lowest cost but also no likelihood that all those things would be produced at all which, if the consumers had the choice, they would like best."

So the standard for judgment under this model:  is there knowledge generation (knowledge about what people want and know regarding their situation, skills, etc.) and utilization such that people are getting what they value (is the human condition better or worse)? 

Note that the outcome is not specified (what it is that makes people happy) -- only that whatever the truth (knowledge) is must be utilized if the outcome that people want is to be gained. 

So what about this profit motive -- is it necessary for knowledge generation and utilization?

This process of knowledge generation is valuable in achieving what it is people want -- the motive for achieving it has to be there (people will act in their own self interest) but it does not have to be "monetary profit."  It can be "I want to feel good about myself and in order to do that I have to achieve something beyond myself -- I have to promote an ideal (religious, personal value, etc.) or I have to help others live better lives in a specific way" (for example).  Can you think of other motivations?

Problem:  one person being motivated by their ideal may not be enough to make it happen -- and there needs to be some kind of feedback as to whether or not a person's goals are being met.  This is why the profit motive is such a nice motive -- the feedback comes in the form of monetary profit or loss -- that tells the entrepreneur if what they are doing matches the "objective facts" as Hayek puts it -- meaning matches what consumers want or not?  Without some kind of signaling device as to how you are doing in achieving your goal -- it becomes difficult, if not impossible, to achieve it. 

However -- who knows what people will come up with in doing this if they have the freedom to try?

c.  The Concept of Efficiency:

Let's look at some different views:

1.  Utilitarian concept of efficiency: 

Allocative and productive -- consumer surplus (utility) lost with monopoly -- perfect under the model of perfect competition.  Remember, this assumes we already know the lowest cost method and opportunity costs of resources.

Policies therefore look for a firm trying to erect barriers to entry in order to be able to have P > MC or P > ATC (depending upon what economist you talk to).

"Welfare economics" is a good example of this.  Costs vs. benefits.

2.  Means/Ends concept of Efficiency:

a.  D. Armentano:  ".. if the means employed by an individual in the pursuit of selected ends are consistent with those ends, then the means or plans are said to be efficiently employed."

Can we apply this to society -- to competition or a social idea of efficiency?

The market process, for example, generates information (profits and losses for example) which helps people coordinate plans -- efficiently employ means.  Does the social process (which comes about because of rules) help individuals coordinate their plans?

So outcomes of this concept of efficiency:

• "Social efficiency" relates only to means, not ends.  There is no such thing as "society" having an end.  Individuals can talk about their own concept of "the good society" but there is no such being as "society."
• Does not require the aggregation of individual costs and benefits (which can't be measured anyway).
• All government actions to prohibit trade are inefficient -- why?  Hinders individuals from using an efficient means they want to use to reach their end (it is efficient because it helps them achieve their end).   Assumes, of course that trade is mutually beneficial.

3.  Ethics View of Efficiency (M. Rothbard, "The Myth of Efficiency"):

He says there are grave fallacies involved in the concept of efficiency as applied to social institutions or policies.

• the problem is not only in specifying ends but also in deciding whose ends are to be pursued,
• individual ends are bound to conflict, any additive concept (adding subjective costs and benefits) of social efficiency is meaningless,
• even each individual's actions cannot be assumed to be efficient -- indeed they probably won't be.

Why?  For an individual's actions to be efficient he would have to possess perfect knowledge of the future.  But we don't.

Example:

The individual's ends are not really given -- always changing with the process.

Therefore, he says efficiency is really a myth.  There can be no valid or meaningful cost-benefit analysis of political or legal decisions or institutions.  Is a law efficient?  Are the antitrust laws efficient?

Ethics (fairness and justice) must be the guide for any consideration of public policy and law.

So property rights and free trade (competition as a discovery procedure) will then ensure the most efficient social setting if one values (if one's ethics lend themselves to) personal and economic freedom, individuals choosing where resources are utilized and how, etc.

There are underlying ethical assumptions to any social theory.  According to Rothbard -- we can't talk about efficiency without talking about ethics.  And even then -- we can't ever know if what we just did was the most efficient way of doing it (so he differs from Armentano a little here).

What do you think?