"Free Entry and Exit" from the Market: Simplifying or Substantive Assumption?

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Abstraction and Economic Analysis

Economic theory, of necessity, presents an abstraction to the reader. Abstraction is required to achieve the perspective that allows for theory, that is to say, understanding and interpretation, to occur. If the abstraction is done well only inessential details are set aside-details that would otherwise divert the theorist from grasping the essential or fundamental elements of the process under examination. For example a study of the mechanisms that cause a moving automobile to stop can reasonably abstract from the vehicle's color scheme.

For this process to be valid it is critical that the theorist distinguish between "simplifying" and "substantive" assumptions. The former clears away the inessential. The latter elevates or prioritizes the inessential--thereby contributing to a distorted understanding. The difficulty is that distinguishing between simplifying and substantial assumptions remains, and will always remain, something of an art. Fifty years ago the siren of "positive economics" proposed that this critical distinction could be reliably made by adhering to a set of clear and simple rules. While some economists and empirical psychologists maintain a nostalgic commitment to that eclipsed understanding of science, today most thinking practitioners are aware that such an epistemological stance, with its triumphant dismissal of the need for defensible assumptions, was naive--even misguided.

Out of this epistemological vacuum economists have retreated to several crude "fixes" to guide their selection of abstractions. Occasional assertions to the contrary, these methods are conventions. Innocent of any knowledge of these issues, many economists instinctively deploy the abstractions used by their graduate advisor or rely on those that most frequently appear in what are held to be the profession's premier journals. Economics, perhaps more than ever, is now defined by what economists do.

Ideally, the distinction between substantive and simplifying assumptions could be grounded in something more meaningful. Such a ground does exist--it is called judgment. Unfortunately judgment, like "beauty" or "goodness," is difficult to define without invoking specific cases. The reason is that good judgment requires a sense of context. Context is most readily gained through direct experience, a study of history, or the comparative method. Once acquired, this knowledge enables the researcher to "compare and contrast" one situation with another, to learn from previous efforts to interpret the subject at hand, or to benefit from multiple approaches to a single question.

In short, judgment requires the kind of broad-ranging knowledge that is largely absent, even disdained, in the training of the economists of our era ("training" is the appropriate term in this context--to be contrasted with "education"). To appreciate the implications and importance of the distinction between "simplifying" and "substantive" assumptions, consider the conventional assumption of "free entry and exit."

The "Free Entry and Exit" Assumption and the Implicit Denial of Bargaining Power

Free entry and exit is almost always presented as a "simplifying" assumption. Several generations of economics textbooks have repeatedly asserted that its value is in enabling students and researchers to grasp the essence of the market process by freeing them from the inessential distractions inherent in the particulars of time and place.

But is this assumption really an innocent simplification? Among the "inessential distractions" it abstracts from is bargaining power. For some markets, such as that for a slice of pizza in New York City, or an espresso coffee in the heart of Paris, we can confidently ignore issues related to bargaining power. However, in most cases understanding the cause, extent, and implications of bargaining power is essential to a coherent theory of market dynamics. …