Friday, July 10, 2015

“Rationality” in the Theory of the Firm... Introduction

I have a Comment in the latest issue of World Economic Review. Please take a look.

A little background. Early last year, I was asked to review a piece by Russell Standish and Steve Keen. Their piece was aimed at salvaging one of their critiques of neoclassical economics. Most significantly, Standish and Keen have made claims (my summary, quoted phrases theirs)
that the textbook model of perfect competition is “strictly false” in assuming the demand function has “dual [contradictory] properties” and thus the model contains a “fundamental flaw.”
Over the course of nearly a year and a half, correspondence with the authors led me to conclude that their critique is flawed beyond all repair. Though I made my concerns known to the editors, WER nevertheless deemed their paper worthy of publication without clarification– let alone correction of errors of fact. I am grateful that the editors permitted me a Comment to run alongside their paper, but it is unfortunate that they also allowed the authors to repeat again their nonsense without meaningfully addressing the concerns I lay out in the Comment. Indeed, the authors respond in part by asserting that I agree with them regarding a point upon which I spent considerable Comment space disagreeing.

I would, however, like to thank the editors of WER for attempting to facilitate a proper exchange. In particular, I thank John Harvey and Norbert Häring for their time. And finally, I thank Russell Standish for his own responsiveness. Standish left me an impression of being a solid fellow interested in dialogue despite the fact that at times I exposed to him my rawest frustration.

Before coming to the point, however, I would like to be up front regarding a very personal opinion. To put Steve Keen forward as a leading light and fail to address the fact that he either misunderstands or misrepresents first-semester undergraduate microeconomics an embarrassment to anyone who would make valid criticisms of the neoclassical orthodoxy. I believe that so long as this is so, it becomes all the more difficult to convince the mainstream that the heterodox community has anything important to say. And if it turns out that I have it all backwards and Keen is correct and I am wrong, then the shame is all the more mine. However, after the better part of a year and a half of trying to engage productively on these issues, I remain convinced of my position.

I am not going to try here to summarize the state of the entire debate, except to reiterate that Keen misunderstands or misstates the theory he is critiquing. Specifically, he substitutes the generally-accepted definition of price-taking for his own. According to Keen, a price-taker accepts whatever price clears the market, given the industry level of production. This gives every firm at least some market power– by adjusting its own output, each firm has the ability to change (albeit indirectly) the price it receives for its production. Such market power runs contrary to the textbook model of perfect competition, in which firms are assumed to have no such market power. By the time firms decide how much to produce, the price they will receive is assumed to be known. Contra Keen, the price is at that point not a function of anything. Thus, Keen’s competitors become entirely indistinguishable from Cournot oligopolists. Little wonder, then, such imperfect competitors do not act like perfect competitors. In short, he uses a model of imperfect competition to argue that perfect competition is mathematically unsound. To paraphrase a certain irate Justice of the U.S. Supreme Court, this is the purest applesauce.

I am not going to lie. Further discussion can get very technical. Though I have already prepared a series of posts responding to their ongoing stream of nonsense, I am not sure what the level of my audience may turn out to be. That said, I will begin to address their response in Part 1.

Before I do, I would like to give shout-outs to folks who have tried to tackle this disaster before me. I think of folks like Donald Katzner and Paul Anglin and– surely– a veritable host of referees.

And of course, thanks to the woman who married me in the midst of all this and its many lost nights.

Read my original Comment (including Technical Appendix) at World Economic Review.

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