# Keen – the demand curve for the perfectly competitive firm

Steve Keen on the demand curve for the perfectly competitive firm

Here is one to think about. Steve Keen argues that the perfectly competitive firm does not face a horizontal demand curve. He draws on an article by Stigler (reference below) which is worth looking at, if only for the introductory discussion of Adam Smith’s concept of competition.

This following is an extract from pp.76-77 of Keen, S. (2011). Debunking economics: the naked emperor dethroned? (Rev. and expanded ed.). London; New York: Zed Books Ltd.

Most of this book explains flaws in neoclassical economic theory that have been known for decades, but have been ignored by neoclassical economists. ‘When I first wrote Debunking Economics, I thought that the argument presented in this chapter was a new critique.

As I found out shortly after the book was published in 2001, it wasn’t: the same key point had been made forty-four years earlier, and not by a critic of neoclassical economics but by one of the most strident defenders, George Stigler. In his paper ‘Perfect competition, historically contemplated’ (Stigler 1957: 8, n. 31), Stigler applied one of the most basic rules of mathematics, the ‘Chain Rule,’ to show that the slope of the demand curve facing the competitive firm was exactly the same as the slope of the market demand curve…

If you haven’t yet studied economics, then the importance of that result won’t yet be obvious to you. But if you have, this should shock you: a central tenet of your introductory ‘education’ in economics is obviously false, and has been known to be so since at least 1957.

Stigler’s mathematics deconstructed the demand curve for the individual firm into two components:

• the slope of the market demand curve; multiplied by
• how much market output changes given a change in the output of a single firm.

Neoclassical theory assumes that the slope of the market demand curve is negative: a fall in price will cause demand to increase. So the demand curve for the individual firm can only be zero if the second component is zero: the amount that industry output changes given a change in output by a single firm.

However, Stigler very correctly stated that this second component is not zero, but instead equals one. In the basic ‘Marshallian’ theory of the firm that is taught to undergraduates, individual firms are assumed not to react strategically to what other firms do or might do. Therefore if one firm changes its output by ten units, there is no instantaneous reaction to this by the other firms, so that industry output also changes by ten units (though it might alter afterwards as other firms adjust to the new market price). The ratio of the change in industry output to the change in output by a single firm is therefore 1.

As a consequence, the slope of the demand curve for the individual competitive firm equals the slope of the market demand curve. Far from the individual firm’s demand curve being horizontal, it has the same negative slope as the market demand curve.

The reference is to Stigler, G. J. (1957). Perfect Competition, Historically Contemplated. Journal of Political Economy, 65(1), 1-17