Perfect competition is the name used for a set of false assumptions of mainstream economists in models that, without those assumptions, could not be applied to real data. In effect, these models create the framework necessary to make economics a positive empirical science. Most assumptions are derived from generalizations about economic phenomena. The field of contemporary economics constantly revises and attempts to strengthen its models to better test economic hypotheses.
Professional economists obviously understand that these parameters are unrealistic and do not accurately represent real phenomena, but many contend that important observations can still be rendered from perfect competition models. Others argue that these models are too fundamentally flawed to produce useful information and are only capable of testing theories that reinforce the nature of the model in the first place.
Arguments in Favor of Perfect Competition Models
Perfect competition models are used in microeconomics to explain and predict the actions of individual actors. To isolate specific variables and quantify their impacts, certain other problematic realities must be assumed away. These include barriers to entry; sticky prices; the role of entrepreneurs; heterogeneous and substitute goods; and imperfect information. The proponents of macroeconomic modeling believe these parameters are acceptable as long as economic modeling produces meaningful results.
Milton Friedman, founder of the Monetarist school and strong advocate of methodological positivism, stated that “complete ‘realism’ is clearly unattainable” and models must “yield predictions that are good enough for the purpose in hand or that are better than predictions from alternative theories.” In other words, economics never has perfect testability and economists should look for the most accurate theories.
Economic author Donald Stengel argued that perfect competition described a desirable end, one that public policymakers and business managers could use to make economic decisions. In a book titled “The Principles of Managerial Economics,” Stengel described how perfect competition models could highlight possible surpluses and deadweight losses to improve efficiency.
Arguments Against Perfect Competition Models
Despite its current orthodox status, many economists have criticized the use of perfect competition models. Critics claim the assumptions remove crucial characteristics of real markets and when those assumptions are dropped, the models no longer yield meaningful results.
F.A. Hayek, who was not entirely opposed to the use of empirical models in economics, said the theory of pure, or perfect, competition had “no claim to be called ‘competition'” because the normal devices of competition are incompatible with the model. These include advertising, undercutting, or offering different products and services.
Economist Walter Block argues that perfect competition produces unrealistic and otherwise impossible results that are nevertheless used to justify irresponsible government policy. He points to antitrust legislation, which uses perfect competition as the benchmark for identifying so-called “market failures.”
Hayek also considered perfect competition to be tautological. As he stated in “Individualism and Economic Order,” perfect competition “confines itself to defining conditions in which its conclusions are already implicitly contained and which may conceivably exist but of which it does not tell us how they can ever be brought about.”