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Perfect Competition and Counterfactuals

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By Stuart Birks

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



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