When you were taught about perfect competition, what was the underlying interpretation of the model?
1. The model is a good approximation: Markets in the real world work about as well – and in roughly the same way – as the perfectly competitive model says. Regulation is therefore generally counter-productive.
2. The model is a foil: Markets only work well if the model’s numerous extreme assumptions hold, so markets in the real world are at best so-so. Regulation is therefore generally beneficial, or even necessary.
3. The model is a special case: Markets work well when its assumptions hold, but the various forms of “imperfect” competition work well when the perfectly competitive assumptions are violated. Regulation – including regulation to make actual markets better match the perfectly competitive assumptions – is therefore generally counter-productive.
Take lectures, assigned readings, and homework into account when you answer. Please state the best of these three response options in the first sentence of your comment before elaborating or proposing alternative interpretations.
Bonus: If you’ve ever taught the perfectly competitive model, what underlying interpretation did you convey to your students?
READER COMMENTS
Nathan
Mar 22 2015 at 11:16pm
Option #3. A few markets (such as agriculture) were held up as examples of perfect competition, but more attention was paid to monopolistic competition – both for its own sake and for its relevance to Krugman’s international trade theories.
Regulation received little attention in any form, outside of tax.
Zac Gochenour
Mar 22 2015 at 11:56pm
Option 3. Must note that my first economics class was an intermediate course so it was probably more nuanced than a typical intro class. And it was at GMU, so we definitely weren’t going to hear option 2.
Bonus: option 3, but I do make an effort to point out that a lot of real world markets work more or less just like the perfectly competitive model.
Bill Friedman
Mar 23 2015 at 12:38am
Option #3 is probably the best fit for how I was taught.
(To elaborate: the professor tried to teach multiple perspectives and tried to refrain from unfavorably biasing us too much in any direction, but he focused on #3 and made it sound the most plausible.)
Max
Mar 23 2015 at 1:28am
Option 1: At both a small liberal arts school in Pennsylvania, and a large commuter state school in south Florida.
Fernando Arteaga
Mar 23 2015 at 2:36am
Option #2 My class was admitedly lefty heterdox. So they weren’t shy in their critiques.
The professor would actually quote some paragraph from Hal Varian’s intermediate micro text and then proceed to criticize it.
Eric Schmidt
Mar 23 2015 at 2:46am
Option #3
Edogg
Mar 23 2015 at 3:02am
Option 3.
Monopolistic competition and oligopolies work well. It’s more like you need extreme assumptions to justify regulation.
Externalities are real, but consider coasian solutions (but Pigovian taxes may still be appropriate). Buchanan’s public choice is relevant.
Rent control sucks.
john hare
Mar 23 2015 at 5:02am
Option 3
No formal class on the subject. I’ve been running a business for 30 years. Perfect anything is an illusion.
Joshua Woods
Mar 23 2015 at 6:59am
Option 2:
I’m currently in my first year of an Economics degree in the UK and option 2 was definitely the impression that was given. Fortunately I read Econlog!
Lupis42
Mar 23 2015 at 8:17am
Option 3.
We went over the perfect competition model, and some real world examples of markets that seemed to behave roughly like it. Then we started talking about theoretical weaknesses, some examples of of markets that would be vulnerable to those and how regulation might correct them. Then we went through how most of those examples had worked out in the real world – i.e. usually worse than the market had been functioning before, despite the theoretical problems.
mike davis
Mar 23 2015 at 9:23am
I teach PC to grad business students and do option #2—kind of. I use the model as a foil, but not as a justification for regulation. Instead, I use it as a chance to talk about what economics can tell you about how to identify opportunity.
I set out the model and then ask them what kinds of real-world businesses look like the model. They answer–correctly–commodity businesses (oil, steel, etc.). I then ask what does that tell them about the opportunities in such businesses. They respond that it doesn’t look good since the model tells you that you should only be able to earn “normal” economic profits. This makes them very sad since MBA students at an expensive private school plan on earning much more than that. We then go on to talk about how the model doesn’t really capture the profit opportunities from (a) the short term gains that come from responding quickly to a shift in the market, (b) the long term profits that come from keeping costs lower than the costs of the marginal firm, and (3) the profits available to a firm willing to take more risk (or, even better, reduce risk) than the marginal firm.
Quinn
Mar 23 2015 at 9:50am
Option 3,
University of South Florida. As an example of perfect competition we looked at something like an onion farmer, homogenous product, then moved to the more imperfect.
ilya
Mar 23 2015 at 9:51am
I don’t understand why there’s no option 4:
4. The model describes some markets better than the others. When its assumptions hold, the results of market interactions will be optimal for market participants. Additionally, if there are no externalities, the results of market interactions will be societally optimal. Government policy will necessary push things away from the optimum.
In cases where markets are imperfect or externalities exist, government policy, including regulation or market participation, may be societally beneficial or not, see many examples.
mobile
Mar 23 2015 at 10:10am
Close to option #1. The perfect competition model is like an idealized physics model with point masses, frictionless surfaces, ideal gases. It’s difficult to find real world situations where those conditions hold, but there is still plenty of good insight about how the universe works to be learned from exploring those models.
glen smith
Mar 23 2015 at 10:59am
Option 3 is the best fit.
Levi Russell
Mar 23 2015 at 11:02am
I was taught Option 2.
Were I to teach an intro micro course, I would use Option 3.
brendan
Mar 23 2015 at 11:35am
#1. As a high school senior I didn’t understand what models were. What’s the point of learning this thing that’s not actually how any part of the world works? It must be a good approximation of real world processes otherwise they’d skip this thing and tell us about how competition really works.
That was my unstated thinking at the time. The idea things are so complex that it’s useful to create intentionally imprecise abstractions was not on my radar.
I think it’s the same for most students on most subjects. Teachers don’t remember when the idea of a model was strange to them.
Hazel Meade
Mar 23 2015 at 11:49am
The answer your probably pushing for is obviously #3. But I think in reality, if you’re talking Econ 101, most people learn #1. Then if they are influenced by left-leaning professors they get #2 a little later. Nobody ever actually gets to #3 until the get in the position of having to argue against #2 having learned #1.
I think #3 at the very least points out that #2’s conclusion doesn’t follow. Even IF markets are imperfect, it doesn’t necessarily follow that any real world regulation is going to help. The best thing we can do, really, is try to get closer to a market where the assumptions do hold. Certain kinds of regulations could help do that, just not ones that very many people are proposing.
Justin Ross
Mar 23 2015 at 11:57am
I teach in a policy school where my students are likely to become “the regulators”, and I teach it somewhere in the grey of these options. I give them the following:
1) PC is pretty good approximation when considering market dynamics (e.g. what will happen in short run and long run in response to an oil demand shock). Other models are more complicated without adding much qualitative improvement.
2) It gives us something to compare to for measuring inefficiency in market analysis. We can’t really measure inefficiency in any market without the perfectly competitive model, but the model also allows some useful predictions to rely on. E.g. “In PC, price equals marginal cost. Over here, this duopoly produces the same outcome, is 50% higher, etc.”.
Point #2 allows me to really highlight that PC assumptions are sufficient, but not necessary. A Bertrand duopoly violates many of the assumptions without producing a meaningfully different result, for instance.
stubydoo
Mar 23 2015 at 12:07pm
In my freshman level class (in the 1990’s), the following area were specifically covered:
Monopoly = bad. They would have a graph showing “deadweight loss”. And they would explain various policy responses that would solve it – price regulation, profit margin regulation, direct provision etc.
Perfect competition = good. No regulation needed.
Real world: no actual perfect competition exists, instead lots of this thing called “monopolistic competition”.
However they never really developed the idea of monopolistic competition, and certainly never got into the matter of whether monopolistic competition ought to be treated as being like monopoly or like perfect competition in terms of the appropriate policy response. And I think that was appropriate – trying to divine the answer to that would have been a bit unfair for freshman level (at least at the school I was at).
(I was also at one point a teacher of Economics, but only macro so not relevant here).
honeyoak
Mar 23 2015 at 12:12pm
Option # 3. I remember thinking that this was the strangest market that I had ever heard of and that it did not approximate anything close to reality. The professor (of Econ 101) tried to defend it by highlighting the international coal market as an example but then a student in the class who came from a coal mining family illustrated the various grades of coal and their different uses.
Mike Hammock
Mar 23 2015 at 12:26pm
When I was first taught intro micro (as a high school AP course) it most closely resembled 2. Having said that, the material wasn’t presented in as extreme a manner as option 2 appears to be–it was more like “Markets often work something like the competitive model, and when they do, government interference (like price controls) tends to screw things up. Sometimes markets don’t work like this, in which case regulation often helps.”
When I took more econ classes in college, the approach was more like option 3.
When I teach intro classes, I go with something like option 3, though I don’t necessarily have the view that imperfectly competitive markets work “well” in absolute terms. Rather, I point out that regulation often goes wrong, so unregulated price searchers are often better than the alternative.
liberty
Mar 23 2015 at 3:04pm
mike davis writes:
“I set out the model and then ask them what kinds of real-world businesses look like the model. They answer–correctly–commodity businesses (oil, steel, etc.). I then ask what does that tell them about the opportunities in such businesses. They respond that it doesn’t look good since the model tells you that you should only be able to earn “normal” economic profits.”
Right, cause everyone knows there is no money to be made in oil…
Slavisa
Mar 23 2015 at 5:14pm
I was taught #1. Now I teach #3 and I am wondering if teaching it even as a special case doesn’t do more harm than good. So I spend a lot of time telling students not to take the textbook chapter too literally. Also made Peter Thiel’s WSJ article on competition a required reading.
Roger
Mar 23 2015 at 6:15pm
I don’t remember what I was taught 35 years ago. My thoughts today are that it is an oversimplification for modeling of what is better described in modern terms as an attractor toward competition. Barriers to competition or a lack of competitors create incentives to compete, and fears of competitor entry cause firms to act as if there is competition.
LD Bottorff
Mar 23 2015 at 8:17pm
I took economics 42 years ago. I suspect that the instructor’s point of view was Number 1. That the Nixon administration gave the instructor many opportunities to point out the difficulty of maintaining a regulatory regime. Wage-price controls had been in effect and when they were lifted, inflation returned. The instructor used a model to show that miss-allocation of resources made inflation worse in the long run.
Alex
Mar 23 2015 at 10:36pm
I was taught option 1, which I think is a good simplification of how things work.
Regulation is usually unnecessary
Bret Sikkink
Mar 23 2015 at 10:39pm
Given that few products are truly homogeneous, #3 seems correct (#4 proposed by commenter above also, but in a question-begging way – why are they different?).
I begin by teaching #1 and discussing the value of observing differences from a baseline model. I would also add that other than homogeneous products, the next most-contested assumption in the model is free entry and exit – the various forms that barriers to entry can take are first really explored here.
One of the deep understandings that students get from seeing long-run profits of zero in my experience has been the profound effects of creative destruction. Also, since very many people ask some version of “if there’s no profit, why stay in business”, the otherwise-academic concepts of economic vs. accounting profit and the all-important opportunity cost come into starker view.
AS
Mar 24 2015 at 9:19am
I was taught #1 and I think most people are too so it becomes a popular strawman argument for those who like activist government. Instead we really need to emphasize that although perfect competition is an imperfect assumption in reality, it still works well enough and even when it doesn’t, the odds of intervention outperforming imperfect markets are very low, and shaped by the political culture of the particular country: countries whose governments have a history of corruption and policy failure should probably err on the side of free markets.
Ian Downie
Mar 24 2015 at 9:41am
I was taught that while perfect competition does not exist in the free market, the alternative of government regulation comes about within a political market that does not even remotely approach perfect market conditions, and is therefore generally inferior to free market results.
Ian Downie
Mar 24 2015 at 9:42am
I was taught that while perfect competition does not exist in the free market, the alternative of government regulation comes about within a political market that does not even remotely approach perfect market conditions, and is therefore generally inferior to free market results.
perfectlyGoodInk
Mar 24 2015 at 8:01pm
None of the above. Much like AD/AS, the model’s main use is to allow students to become comfortable with various concepts before moving on to more complex and realistic models (I believe monopolistic competition is the prevailing one used in macroeconomic models).
I also believe that it is inappropriate for an instructor to use their classroom authority to advocate for a specific political belief, such as explicitly arguing for or against more or less government regulation of the market. When covering controversial issues, instructors would best serve their students by presenting both sides of the debate.
Yes, there are many liberal instructors who do the same, but two wrongs don’t make a right. I’ve heard some liberal professors argue that they are simply countering the conservative bias at the K-12 level.
Daublin
Mar 25 2015 at 9:00am
Regulation was not brought up in my micro class. In fact, I had no idea back then that economics was often reduced to being a political talking point rather than an attempt to understand how the world works.
My teacher just walked us through the model, how the parts of it match intuitive concepts of reality, and the implications of that model. I remember the class balking at the suggestion that a perfectly competitive market would lead to firms with a profit margin of zero, but after everyone had a moment to balk, she gently walked us through why the model predicts it. She then briefly discussed some counter-balancing forces that the model doesn’t include, such as cost of entry.
Stepping back, I am deeply uncomfortable with setting “regulation” in opposition to markets. Yes, market fans are distrustful of 1000-page regulatory documents when it would work just as well to have a five-pager setting the basic rules of engagement. However, the problem seems to be the length, not the nature. Maybe the debate should be about “big law” versus “simple law”. Big law has numerous problems that are intuitive and that can be understood by all citizens.
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