Wednesday, February 19, 2014

Economists blithely write “Economists blithely draw…”

Sometimes, I’m going to have to be critical of specific people. Generally, I prefer to be critical of people who disagree with me on policy. Sometimes, a potential ally will make me wince but I let it go. Then there is Steve Keen.

Sometimes, I just don't know what the man could be thinking, driving me to rise to the defense of someone unlikely. Take, for example,
Economists blithely draw diagrams like Figure 23 below to compare monopoly with perfect competition. As shown above, the basis of the comparison is false: given Marshallian assumptions, an industry with many “perfectly competitive” firms will produce the same amount as a monopoly facing identical demand and cost conditions— and both industry structures will lead to a “deadweight loss”. However, in general, small competitive firms would have different cost conditions to a single firm—not only because of economies of scale spread result in lower per unit fixed costs, but also because of the impact of economies of scale on marginal costs.
(PDF source)

Zing! It seems Keen and co-author Russell Standish have Mankiw dead to rights. It appears that Mankiw have made a terrible mistake and did not think about the fact that the marginal cost curve would be different for the industry as a whole. Or so they would have it.

I find this highly unlikely. Their claim that their paper shows that “given Marshallian assumptions, an industry with many ‘perfectly competitive’ firms will produce the same amount as a monopoly” is a matter for another time. For now, it suffices to note that in presenting this figure Mankiw is not referring to “perfect competition” at all. Mankiw leads his discussion saying
We begin by considering what the monopoly firm would do if it were run by a benevolent social planner. The social planner cares not only about the profit earned by the firm’s owners but also about the benefits received by the firm’s consumers. The planner tries to maximize total surplus… the socially efficient quantity is found where the demand curve and the marginal-cost curve intersect. [bold added to original, italics in original]

The framework for the discussion is monopoly. The discussion concerns the deadweight loss of a profit-maximizing monopoly in contrast to a socially-planned monopoly. In such a context, the monopoly is the industry, so there is no confusion regarding costs. The “efficient quantity” is “efficient” because no monopoly can produce larger total surplus. Mankiw's figure simply does not “compare monopoly with perfect competition” as suggested. Keen and Standish grossly misrepresent Mankiw.

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