A Reconsideration of the Theory of Perfect Competition
24 Pages Posted: 18 Apr 2015 Last revised: 31 Mar 2016
Date Written: April 14, 2015
This paper develops a discussion and provides the basis for a dispute of the principal assumption on which the classical-neoclassical theory of perfect competition is based: is it indeed true that the individual product demand of each producer is perfectly elastic (horizontal) and the price is determined by the intersection of the total demand and supply curves of the produced good?
Firstly it is argued that this principal assumption is not valid. One of the arguments of outstanding importance is that this crucial assumption leads to an inconsistency: while at firm level the equalization of supply (marginal cost) and demand maximizes the profit of the firm, this does not hold true at the aggregate market level, while it should as it is mathematically proved.
By challenging the above assumption and adopting a typical demand curve for the firm, for which this paper provides further reason as a concept, the aforementioned inconsistency is reconciled. We are then being led to noteworthy conclusions, considerably different from those of the classic theory. More specifically, the classic theory of value and of perfect competition as well as other fundamental outcomes of Economics are totally negated since: the infamous principle of price determination by the intersection of total demand and total supply is invalidated, as well as that of the equality of price to the minimum average cost in the long term, facts that move social welfare away from its optimum, as it is claimed by the classic economic theory; in addition, in the labor market labor is not paid according to the value of its marginal product but according to the marginal product revenue, which implies the monopolistic exploitation of labor and lower wage and employment levels and in fact worsens the previous social welfare's declination. Finally in Macroeconomics and specifically in the General Equilibrium Theory, the equilibrium of each market by the equation of total demand and supply should be replaced by the new principle maximizing the aggregate profit of the industry for each market.
Keywords: non-perfectly elastic demand, price determination, equilibrium at firm and at market level, integrated industry profit maximization, social welfare deviations
JEL Classification: B13, B21, D21, D41,D46, D50, D60, E10
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