Home > Uncategorized > Perfect competition and counterfactuals

Perfect competition and counterfactuals

from Stuart Birks and new issue of WEA Commentaries 7(6)

From: P.17 of Birks, S. (2015). Rethinking economics: from analogies to the real world. Singapore: Springer.

Market failure is defined in comparison to the ideal of perfect competition. An alternative is needed for comparison, and value judgments must be applied to justify one situation being considered superior to another. This raises two questions:

(i) Is perfect competition the right ‘ideal’?

(ii) If it is, then given that the counterfactual is an important aspect of any policy analysis, should economic analyses compare a real situation with an unattainable ideal such as perfect competition? 

Theory is, in essence, an intellectual exercise, whereby structures are presented and implications drawn. There is no a priori reason to assume that they in any way accurately reflect, or even closely approximate, the real world. At a most basic level, considering the distinction between ontology and epistemology, any description relies on the classifications afforded by the mode of expression, as with the use of language. There is not a one-to-one correspondence between words in different languages. Even if there were, the link from language to the phenomena that the words describe is not precise, if only because of the aggregation and discrete distinctions implicit in language. Consequently, descriptions cannot precisely reflect the real world.

Sen summarised the situation in his paper on ‘Rational Fools’ (Sen 1977). In it he described Edgeworth’s analysis on the possibility of egoistic behaviour achieving general good as an abstract query, not intended to reflect reality. Economists have taken something that was intended as an intellectual exercise, paradoxically extending it to become a combined answer to questions of ‘how people actually behave’ and ‘how people should behave’.

This is a serious paradox. Is no education required to improve people’s economic decision making? If so, why is it accepted that education is required to increase understanding in other areas of activity? In any event, can economic decisions be considered in isolation?

Sen, A. K. (1977). Rational Fools: A Critique of the Behavioral Foundations of Economic Theory. Philosophy and Public Affairs, 6(4), 317-344.

From: p.13 of WEA Commentaries 7(6), December 2017 https://www.worldeconomicsassociation.org/files/2018/01/Issue7-6.pdf

  1. Frank Salter
    January 5, 2018 at 7:22 am

    The statements:

    “Theory is, in essence, an intellectual exercise, whereby structures are presented and implications drawn. There is no a priori reason to assume that they in any way accurately reflect, or even closely approximate, the real world.”

    would provoke outrage if they had been made in a scientific forum!

    A scientist reading those words, in an economics forum, would merely have belly-laughed and concluded that economists were ignorant/stupid/ridiculous (those are the kindest words) and also that economics in no way is to be considered a science but a pseudo-science with delusions of grandeur!

    I waited a day to see if any other comment was to be made about these two sentences. That there has been none is perhaps a demonstration of the failure of academic economic thinking to apply critical fundamentals of scientific analysis.

    However, even for theories to be considered candidates for scientifically validity, it is a necessary condition that they “accurately reflect, or even closely approximate, the real world”. If this simple critical step were applied and invalid theories derided for being mere arrant nonsense, some progress may be made. I can speak authoritatively only about production theory. All so called theories based on production functions are clearly wrong. They all fail the tests of dimensional analysis. So why do they still survive? Perhaps the answer lies in the two sentences quoted!

    • Frank Salter
      January 5, 2018 at 11:16 am


      For scientifically validity — please read
      either scientifically valid
      or scientific validity

    • Rob Reno
      January 5, 2018 at 8:46 pm

      Thank you Frank for bringing my attention to this post and the book it references. I wish I could say I understand clearly everything, but I am just too new to the study of the field of economics to reach the depth of some of your and others comments, and I fear if I ask neophyte questions I will either waste your time or show my foolishness ;-) Nevertheless, I do feel that I am learning something of value even though I know much is beyond my current state of knowledge.

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