Saturday, August 9, 2014

The Myth of Perfect Competition

I have written extensively about the standard textbook claim that under perfect competition you'll get higher quantities at lower prices compared to a monopoly situation, and the strange fact that this proposition somehow cannot be reproduced in a computer simulation. Instead, the simulation consistently shows the same quantities at the same prices for perfect competition as for a monopoly. I am particularly interested in this result because in Switzerland later this year a referendum is being held on whether to abolish "competition" in the so-called health insurance market and install a government-run single payer monopoly instead. Of course, the claim that competition keeps quality up and prices down is heard everywhere. But apparently it cannot be scientifically shown to be true.

I've come across two explanations as to why the situation called perfect competition is unstable, and why therefore prices and quantities might converge to monopoly levels. Both of these start by asking what would happen if a firm chooses to demand a higher price than the equilibrium price at perfect competition. The theory claims that consumers would simply abandon such a supplier and fulfill their purchases elsewhere which in turn would discourage such a deviation. However, beyond mere assertions to that end the theory fails to show that this is indeed so.

Joseph Stiglitz, for example, says that the process of switching to a new supplier involves a certain cost (looking for a new supplier, driving farther, etc), and as long as the price increase is lower than the cost of switching, the consumer is better off if he remains with the supplier, despite the higher price.

This may be so, but there's a more serious problem with the theory (cf The Economics Anti-Textbook by Hill and Myatt): It is not certain at all, that the other suppliers are able or indeed willing to absorb these defecting customers. Economists, of course, will claim that because the firms are small, the number of defectors is small enough and thus easily absorbed by the remaining firms. But if the firms are small, it also implies that one or a few additional customers are being felt by those firms that receive them. The fact that firms are small cuts both ways. In any case, however, the firms are unable to absorb additional customers for a simple reason: they are already operating at the sweet spot where the production capacity is maximized and marginal cost equals marginal revenue. One additional unit produced and — because of the rising cost curve (remember?) — the firm incurs a loss. The firm has thus two options: refuse to serve the customer or raise the price, which, according to the theory, will drive away customers and hence inflate the number of defectors even further.

But consider what happens if only a single customer is willing to accept the higher price, e.g. because there is no place else to go: the firm serving this one customer will make a positive profit because it can successfully charge a price above marginal cost (remember that because MC = MR, all other firms make no profit at all). The theory implies that this cannot possibly happen as no customer would pay a higher price, given all the fabulous competition among firms. But at the same time it fails to show that the customer has any other place to turn to, and Stiglitz suggests that the customer may actually benefit from staying.

But this is not all: because all participants in perfect competition, firms included, have total knowledge, they all know that any small raise in price has the potential to lead to a positive profit because no other firm is able to absorb any possibly defecting customers. Therefore a few might stay. Remember that one single loyal customer is enough. Knowing all this, all firms — who are profit maximizing after all — will exhibit a tendency to increase prices just a little in order to exploit this non-negligible potential for profit. This tendency acts like an electromagnetic force between equally charged particles that will eventually drive prices away from the so-called equilibrium point towards the only real stable equilibrium price point: at monopoly level.

There you have it. The whole myth of perfect competition that rests on a completely fabricated assumption (of rising marginal costs) cannot be verified in a computer simulation. Instead, prices appear to converge at monopoly levels even for hundreds of thousands of profit-maximizing and non-colluding firms that compete in a market. Furthermore, a plausible story exists that explains why this is indeed a possible or even likely outcome given all assumptions presented. Will any of this change any debate anywhere on this planet about markets vs state-run monopolies?

Take a guess.

Monday, July 28, 2014

The Science of Economics

I often get some heat when I make the claim that economics isn't science. Science is not a field of study but a method of study, they say, which is sort of true. Alright then, let's be more precise.

Economics is the scientific study of "the economy" in the same way that theology is the scientific study of God.

Theology is a very peculiar kind of science, because the object of study — God — does not reveal himself to those that engage in the studying. Nobody has ever interviewed God. Nobody has even seen him or can prove his very existence, so nobody can know what God really thinks or wants (not that this fact stops some people from acting as if they did). Now, of course, you can still do science and study revelation and religious practice and rituals using the historic texts (e.g. the Bible), but you will only learn what people thought God wanted, what people believed, and what people did to share that belief — even with people that didn't care. So the study of God (the literal meaning of "theology") is not so much about God but about the people who do the studying. So it's really like doing alien research, for example by interviewing people who claim to have been visited or abducted by aliens. Here again, through these interviews will learn absolutely nothing about aliens. You will only learn about the people (and the minds of those) that make these alien claims.

In the same way that theology (or alien research) is not the scientific study of God (or aliens), economics is not the scientific study of the economy. Now, in contrast to (earth-visiting) aliens there is an economy to study, but the science of economics does not care about the real thing. As I've shown in an earlier post: when confronted with facts in the real economy that contradict claims in their economic theory they dismiss the former by saying that you needn't bother with facts as they don't matter. Only economic theory does. In the words of David Stockman: "People will never agree about the facts, but it's logical..." (Here's the video. The quote is at 7'30").

There is ample literature that shows that the science of economics distorts inconvenient facts in their textbooks (1), replaces hypotheses that are both plausible and empirically observable by other hypotheses that are neither (2), but that just so happen preserve the desired ideological properties of the economy (e.g. equilibrium), or simply makes stuff up and presents it a logically derived theory (3).

Here are a few books that prove all the above claims, and much more. I can only recommend that everybody who cares about the well-being of the economy in general or the middle class in particular reads some (or all) of these books to inoculate oneself against the nonsense that is economic "theory"
  1. The Economics Anti-Textbook by Rod Hill and Tony Myatt
    This book serves both to teach and debunk microeconomics. Each section starts with a summary of the theory as presented in a textbook, and then proceeds to show where ideological bias, logical inconsistency or simply empirically unfounded invention taints, distorts or invalidates the theory. Hill and Myatt don't always disprove the theory but show convincingly that more plausible alternatives exist. Helpful questions for your professor allow economics students to probe their teacher's openness to reasoned debate.
  2. Zombie Economics by John Quiggin
    Quiggin's book is particularly enlightening about economics' unwillingness to accept empirical evidence. Analyzing the most important factors that led the world into the financial crisis of 2007 he shows a) how these theories contributed to the crisis, b) how the crisis disproved important claims of these theories, but most importantly c) how the economics profession keeps defending these refuted claims tooth and nail, despite all the evidence that the crisis piled on their doorstep.
  3. Economics for the Rest of Us by Moshe Adler
    Adler does not actually debunk any of the theories he's discussing in the book, but he shows that they were conscious choices by economists in the face of better, more plausible theories because they had ideological bias against these theories or any of their (sometimes distant) implications.
Each of these books shows convincingly that the so-called value-free science of economics consciously chooses theory that fits its ideological pro-market bias and summarily dismisses any that contradicts it (or that leads to an ideological conflict down the road). This pre-determinism alone is sufficient to disqualify economics of the label "science". But what these choices also show is that economics does not really care about the economy "out there". Instead, economics is an attempt to indoctrinate the peoples with a certain purely made up conception of the economy where the Free Market guides everything perfectly and flawlessly with its Magical Invisible Hand. In that respect, economics is not that different from theology.

Saturday, June 28, 2014

My Music Blog

Sometimes you need some time off, especially if you're writing about mainstream economics. There's only so much inconsistency, illogicality or ideology that you can take at any one time. I for one need a valve to vent off, and in my case that's music. I own a Yamaha MOX6 and a small collection of home-made analog synthesizers and use them to produce music, or just tickle the ivories, as the saying goes.

I have several songs in the pipeline in various stages of completion, and will be publishing them as soon as I deem them finished. If you like music, and enjoy a few minutes off my rants on economics, you're welcome to take a look at my music blog YoshiMusix and/or my YoshiMusix channel on YouTube where I also occasionally present one or the other of my do-it-yourself electronics projects.

And now back to business!

Sunday, May 11, 2014


The other day I was looking for ... oh well, to cut a very long story short, I ended up on the page of the Swiss Association for Critical Thinking (Sceptics Switzerland [German]) when on their FAQ I found the following little gem. Not that I didn't know before, but the neat and concise formulation reminded me of something. Let's see if you can guess what I thought they were referring to [translated from German]:

What is pseudo science?

Pseudo science is something that pretends to be science, but in fact isn't, mainly because it does not rest on the basic criteria of the scientific method.

How do I recognize pseudo science?

Pseudo science violates the criteria of the scientific method usually in one or more of the following ways:
  • Pseudo science regards research solely as a means to confirm the corresponding doctrine (no openness to outcome)
  • Pseudo scientific teachings are formulated as absolute truths (that cannot be refuted)
  • Subjective, untestable and non-repeatable anecdotes are presented as would-be proofs (non reproducibility)
If that is not a definition of the so-called science of economics, I don't know what is.

In Switzerland a referendum is soon being held on whether to establish a minimum wage [German], and the debate centers around the usual claim that a minimum wage causes unemployment. Practically every reference to the mountain of research that has contradicted this claim is countered using an argument that fits one of the points above. The minimum wage opponents simply want the claim to be true and will disregard any empirical evidence to the contrary based on the most spurious claims.

Thursday, April 3, 2014

More News from the Bookshelf

In a previous post of the same title, I promised to write a review of the book The Economics Anti-Textbook by Rod Hill and Tony Myatt, and I can herewith unambiguously state, that I may perhaps do that -- provided I'll ever get to it. The problem is that in the meantime I bought and read Zombie Economics by John Quiggin, and I must say that this is essential reading for anyone who wants to be taken seriously in economics debates. Indeed so much so, that I reserve the right to ignore anything anyone says who has not read it.

Zombie Economics deals with economic models and theories that found a horrible death as a result of the financial crisis, but that still walk among us like those rotting and stinking corpses familiar from dingy zombie movies. Prof. John Quiggin does a great job in systematically debunking the theories that brought about the financial crisis, by first explaining the theory, then showing how it contributed to the crisis, how and why it died, and finally how it crawled from the grave as a zombie to wreak further havoc on an economy still struggling from the crisis.

Highly recommended!

Thursday, March 13, 2014

Sie werden nie aufhören....

...bis sie uns auf die bleichen Knochen ausgebeutet haben. Ich habe vor einiger Zeit einen Beitrag über das Trans-Pacific Partnership Abkommen geschrieben, und dabei davor gewarnt, dass solche Abkommen die Tendenz haben, plötzlich auch für uns bindend zu werden. Die Warnung war berechtigt: Zur Zeit wird in vollkommener Geheimhaltung vor den betroffenen Völkern der EU das Transatlantische Freihandelsabkommen (TTIP) zwischen der EU und den USA verhandelt.

Das folgende Video erklärt, worum es geht, und vor allem, dass es unbedingt zu verhindern ist, weil es die Völker und Staaten der EU für alle Zeiten zu Knechten multinationaler Konzerne macht.

Welcher anständige Bürger eines dieser Länder würde sein Volk in dieser Weise an die Interessen multinationaler Konzerne verschenken? Hat der Wirtschaftsliberalismus nicht schon genug Schaden angerichtet?

Weitere Informationen unter: TTIP unfair handelbar und TTIP stoppen (Petition).

Die Kolumne von George Monbiot im Guardian enthält ein paar Details zur neu geschaffenen Möglichkeit von Konzernen im TTIP, Staaten zu verklagen, wenn demokratische Volksentscheide die Profite der Konzerne zu schmälern drohen.

Und wer die Lügen der Liberalen glaubt, dass dies nur eine rein theoretische Möglichkeit sei und daher für die Demokratie überhaupt keine Gefahr darstelle, sei daran erinnert, dass gegenwärtig auf der Basis einer ähnlichen Regelung die Bundesrepublik Deutschland vom Vattenfall-Konzern in Milliardenhöhe verklagt wird, weil das Volk die Frechheit besessen hatte, in seinem eigenen Land die Regeln bestimmen zu wollen.