Perfect Competition #1

The economic theory of perfect competition is critiqued in the first two chapters of George B. Richardson’s Information and Investment: A Study in the Working of a Competitive Economy (link).

The theory is a much celebrated attempt to reduce the working of a competitive economy to essentials. Its importance to economists is two-fold. As an instrument of analysis it has held a central position in economic theory for a long time, much due to the ease it lends to mathematical formulation. Second, the prices and outputs associated with perfect competition, in its supposed equilibrium state, have a normative significance, in that they are consistent with the optimum conditions of production and exchange. Perfect competition hence represents an ideal with which actual competitive organization may be compared.

Richardson criticizes the theory in two ways – its concept of equilibrium and what it says about the knowledge of entrepreneurs, and the information available to them (Information and Investment pg.1-2).

The concept of equilibrium is addressed in Chapter 1. The concept is used to say what particular actions are taken in response to the prevailing conditions, such as a change in aggregate demand. The perfect competition model assumes numerous individual economic actors who have equal knowledge about their market, no control over prices, are mere traders of homogeneous goods, and have little or no control over the nature of the goods. In the simplest case, the economic activity in each time period repeats itself, becoming a stationary state. The same amount and kind of product or service is both produced and consumed each time period. How this stationary state came or comes about is largely unexplained.

However, entrepreneurs act not merely on what they know, but also what they expect. Moreover, they may alter the nature of goods and services they offer. Consumers may alter how much they buy and the mix of goods and services they do buy. Both kinds of alterations imply disturbances to the existent equilibrium.

Summarizing, the “theory of the maintenance or the attainment of equilibrium under perfectly competitive conditions fails to account for the process of adjustment in terms of investment decisions by individual entrepreneurs, who have expectations which they could reasonably be presumed to form, on the basis of information which can reasonably be presumed to be available” (28).

My next post will be about Chapter 2, information available to entrepreneurs.