Some Sins of Textbook Economics

Article excerpt

People who are ignorant of economics are susceptible to all sorts of misunderstandings. Fortunately knowledge of even just the basics of sound economics is a powerful inoculant against many dangerous falsehoods and half-truths.

This fact, however, does not imply that exposure to more economics is necessarily good. The sad reality is that economists too often present their analyses of markets in ways that confuse not only unsuspecting noneconomists but also - and too often - economists themselves.

A frequently encountered instance of this confusion is economists' discussion of competition. What introductory economics textbooks describe as "perfect" (or "pure") competition resembles nothing that occurs in the real world. In the world of the textbooks, firms don't differentiate their products from those of their rivals. Firms never try to win more customers by improving the quality of their products. Also, firms don't advertise. Indeed they don't even cut prices because each "perfectly competitive" firm is a "price taker": It's too small to affect the market price and so can sell as much as it wishes at whatever price prevails in the market.

These and other problems with the model of "perfect competition" have been pointed out repeatedly, especially by economists steeped in the Austrian tradition - see, for example, Hayek's essay "The Meaning of Competition." Yet the typical economist still clings to the notion that "perfect competition" is perfect competition. This typical economist, it must be admitted, does understand that the conditions necessary for "perfect competition" to prevail in actual markets can never exist. But the model remains the ideal against which real-world markets are judged. The closer real-world markets appear to be to textbook "perfectly competitive" markets, the more competitive real-world markets are assumed to be.

And competition being a good thing, this typical economist presumes that policies advertised as moving real-world markets closer to the "perfectly competitive" ideal are desirable.

Assumed Conclusions

But such a presumption is unwarranted, in part because many of the conclusions of the analysis are snuck into the model's initial assumptions.

Most important among this model's foundational assumptions is that competitive forces play out only in the form of price cuts. Therefore anything that prevents prices from being cut (down to levels that the model specifies as appropriate) is regarded as an obstacle to competition - indeed, as an element of monopoly that prevents the economy from operating more efficiently.

To this day, many mainstream economists describe any firm that can raise, even modestly, the price it charges for its product without driving away all of its customers as possessing some monopoly power.

Note the confusion: A pest-control producer that aims to increase its sales by making a better mousetrap is regarded by this model as behaving monopolistically! Competing for customers by doing something other than simply cutting prices is, according to the model, not competitive.

You can't make this stuff up.

Another example of how economists commonly confuse themselves (and others) involves the issue of "market failure." That same introductory economics textbook that teaches the model of "perfect competition" explains a few chapters later that markets perform suboptimally whenever some groups of people act in ways that affect other groups of people without the consent of these third parties. …