The assumptions economists make

The assumptions economists make is the title of a book published in March of this year and for which a review is located here.  It sounds a little interesting so I have suggested it for purchase by our local library.  I’m not sure it is interesting enough to spend $25 for my own copy.

However, the title reminds me of my own struggles with the assumptions of perfect competition.  So here is a post from almost two years ago about the assumptions of perfect competition and how one could interpret them.

 

Perfect competition utopia

When I started studying economics and learned about perfect competition and its assumptions I thought it was totally unrealistic. I really enjoyed the joke about the economist who wanted to assume he had a can opener.

However, through the years I have come to see perfect competition as an utopia which provides guidelines for policy. I like the perfect competition model because it provides high efficiency, equality in that there are no profits, it works without economic growth and decision making is by individual consumers rather than governments.

One of the features of perfect competition is that there are no profits because if profits are being made in an industry others will enter that industry increasing competition and driving prices down until there are no more profits.

To get around this no profit feature business people lobby governments to pass legislation which restricts competition. For example, subsidies, some taxes, licensing, copyright and patent legislation all interfere with perfect competition.

To make our economy more competitive we should:

– Give subsidies to consumers rather than producers. This way prices will reflect true costs and buyers can make decisions according to their own values.

– Require producers to provide consumers will all relevant information about their products.

– Abolish patent and copyright legislation.

– Unilaterally abolish import and export tariffs.

Following is a summary of the assumptions for perfect competition.

The link for the website from which they were taken is http://tutor2u.net/economics/content/topics/competition/competition.htm

Assumptions behind a Perfectly Competitive Market

1. Many suppliers each with an insignificant share of the market “ this means that each firm is too small relative to the overall market to affect price via a change in its own supply “ each individual firm is assumed to be a price taker

2. An identical output produced by each firm “ in other words, the market supplies homogeneous or standardized products that are perfect substitutes for each other. Consumers perceive the products to be identical

3. Consumers have perfect information about the prices all sellers in the market charge “ so if some firms decide to charge a price higher than the ruling market price, there will be a large substitution effect away from this firm

4. All firms (industry participants and new entrants) are assumed to have equal access to resources (technology, other factor inputs) and improvements in production technologies achieved by one firm can spill-over to all the other suppliers in the market

5. There are assumed to be no barriers to entry & exit of firms in long run “ which means that the market is open to competition from new suppliers “ this affects the long run profits made by each firm in the industry. The long run equilibrium for a perfectly competitive market occurs when the marginal firm makes normal profit only in the long-term

6. No externalities in production and consumption so that there is no divergence between private and social costs and benefits.

The Euro zone’s impossible dilemma

Some economist are worried that attempts to deal with the euro zone crisis are going to force Europe into a recession.  Here’s a link to one such forecast.

It’s a valid fear but one that applies to the whole planet rather than just Europe.  The probable cause of a world-wide recession is that we are using resources at a rate which is not sustainable.

If this is true then policy makers face an impossible dilemma.

Policies which lead to recession will hurt a lot of people and especially the poor.  In this case the line between rich and poor will likely be quite high.

The conventional wisdom is that to deal with a recession governments should spend to stimulate the economy even if they have to go massively into debt.

Stimulating the economy when there is resource depletion is going to deplete resources even faster and will bring forward a major crash.

A further complication is that the Euro zone financial crisis will likely lead to a sharp reduction in the money supply.  Without money the exchange of goods and services will be curtailed.

Resource depletion combined with a loss of money supply has the potential to be disastrous.  But it should leave a few resources for the survivors.

Why we hate bankers

The following was posted as a comment on The Economist website to an article on demonizing bankers in the January 7, 2012 issue.

http://www.economist.com/node/21542389

The reason bankers are the focus of economic frustrations is that they create money when they make loans.

By creating money they have lots of opportunities to take cuts for themselves, they have the power to say what projects go ahead and by whom and they get to charge rent (interest) on the money they create.  Those are three good reasons for people to hate them and for bankers to tolerate the hatred.

(The author of this comment has a web log on economics at https://economics102.wordpress.com/)

%d bloggers like this: