Appendix: Keens problem with the mathematics of competition1

Consider a rm producing in a marketplace, the ith among many. Neoclassical economics requires for its claims here Perfect Competition, namely that (1) there are many rms so that none of them have a large market share, lest their production quantity inuence the market price, and (2) rms produce identical products (commodities), so consumers have no reason not to follow the cheapest price2 . Under such conditions, there will be a market-wide price, P . The ith rm will have a prot i which depends on the quantity produced and sold by the rm (qi ), the market price, and the cost of manufacturing qi items, Ci , which is particular to the processes of rm i. By denition, prot for rm i is its revenue P qi minus its cost of production Ci : i (qi ) P qi Ci As per high school maths, the quantity qi that maximizes prot i (qi ) is the one that makes its derivative with respect to qi zero. 0 = i (qi ) =
d(P qi ) dqi

Ci (qi )

(1)

Now, at this point neoclassical economists use the Perfect Competition conditions to assert that P is independent of qi the ith rm is too small to inuence the market with its quantity P qi ) i qi , so that d(dq = P dq dqi = P . This gives them the result that prots are maximised when i 0 = i (qi ) = P Ci (qi ) (Standard result contestded by Keen) In other words, prots are maximum when the Ci (qi ), the marginal cost, equals the price. This is the optimum output rule for a rm in perfect competition3 . Instead of settling there, lets continue expanding the mathematics from equation (1) without using the Perfect Competition shortcut.
dqi dP 0 = P dq + qi dq Ci (qi ) (Product rule) i i dP = P + qi dqi Ci (qi ) dP Compare this with equation (2) and note that the two are the same if and only if qi dq = 0. i This is eectively another phrasing of economists perfect competition that they assert in order to get their standard result, since P is independent of qi if no rm has an inuential market share, dP meaning dq , and hence the whole term, is zero. But lets still eschew the perfect competition i heuristic and just grind out the maths... dP dQ 0 = P + qi dQ dqi Ci (qi ) (Chain rule) ?

(2)

where Q is the total output of the commodity in question from all rms, ie Q =
dP 0 = P + qi dQ dP = P + qi dQ d(
j

j qj .

Thus,

qj )

dqi dqj j dqi qj j qi j i,j

Ci (qi ) Ci (qi )

(Denition of Q) (By linearity of dierentiation)

= P+ = P+ = P+
1

dP qi dQ dP qi dQ dP qi dQ

Ci (qi ) (Marshal s assumption see below) C i ( qi ) (Denition of Kronecker Delta) (i,j = 1 when i = j and 0 otherwise)

C i ( qi )

S Keen and R Standish. Debunking the theory of the rm. In: Real World Economics Review, Iss. 53 (2010). url: http://www.paecon.net/PAEReview/issue53/KeenStandish53.pdf. 2 Paul Krugman, Robin Wells, and Kathryn Graddy. Essentials of Economics. 2nd. Worth Publishers, NY, 2010. 3 Ibid.

Marshalls assumption is that individual rms are assumed not to react strategically to what other rms do or might do4 . What this really means is that the variables {qi } are independant dq q of each other. In that case, dqj = qj . i i Assuming Marshals condition holds, the last equation above is mathematically equivalent to the equation whose zeros give the maximum of the very rst one (ie to eq. (1)). Comparing again with the contentious eq. (2) suggests that, if the two are to be equivalent if the standard result stated for a competitive rm is to be derivable from the above equation, which is equivalent to dP eq. (1) (in the context of Marshals assumption) then it requires that qi dQ = 0. Now, it cannot be that qi is naught: manufacturers must manufacturer something. Thus, the only way dP = 0. the standard result can be true is if dQ dP And here we arrive at a contradiction, for dQ is the slope of the demand curve for the whole marketplace, and another central tenet of neoclassical economics is that this must always dP be negative, that is, always downward sloping. It cannot be zero. For neoclassicists, dq can i certainly be zero indeed, they insist it is, since thats the mathematical way of stating that the market price is independent of how much any individual producer produces, but this isnt dP the case for dQ . What the derivation above has demonstrated is that these two expressions are mathematically equivalent, modulo Marshals condition. It is a failure of neoclassical economists that they have dierent values, and it suggests that at least one of the three assumptions that have been used to produce this contradiction are wrong: Marshals assumption, the claim that the demand curve slopes invariably downwards, or perhaps the assumption of conditions that give a market-wide price P. In dierent arguments elsewhere5 , Keen relays other reasons for the failure of the Optimum Output Rule, which was rst demonstrated by William Gorman in 19536 who completely failed to recognise what he had proven, and was then rediscovered and publicised in the 70s as the Sonnenschein-Mantel-Debreu Theorem(SMD)78 . SMD says that the demand curve for a whole marketplace cannot be downward sloping at all points except when there is only one consumer and one commodity; the market-wide demand curve cant mathematically exist as traditionally conceived. But even the worrisome SMD result is compatible with a market-wide demand curve that is mostly downward sloping; the above derivation suggests that, for neoclassical economists Optimum Output Rule in perfect competition, the market-wide demand curve must be never downward sloping, nor indeed ever upward sloping. The failure of the Optimum Output Rule presents an ethical problem for economics, for whom price is related to utility the benet derived from a good. Jeremy Bentham founded economics with his work on utilitarianism, the philosophy that the most ethical course is one that maximises benet (utility) across society The greatest good for the greatest number. This hinges on a measure of utility. Bentham decided that a suitable measure of the utility of a product is what people are willing to pay for it ; when people spend money on an item, neoclassical economics takes this as an armation of their belief that the item is worth at least that much. Thus, the promise of the Optimum Output Rule is that it doesnt merely maximise prots, but that it maximises the benet to society. With that rule gone, so too is the ethical justication for the basis of laissez faire capitalism.

See ch. 4: Size does matter/Prelude: the war over perfect competition of Keens book. Steve Keen. Debunking Economics, 2nd. London: Zen Books, 2010. 6 W M Gorman. Community preference elds. In: Econometrica (1953). 7 Wikipedia. The Sonnenschein-Mantel-Debreu Theorem. url: http : / / en . wikipedia . org / wiki / Sonnenschein%E2%80%93Mantel%E2%80%93Debreu_theorem. 8 Frank Ackerman. Still dead after all these years: interpreting the failure of general equilibrium theory. In: Journal of Economic Methodology 9:2, 119139 (2002). url: http://www.ase.tufts.edu/gdae/Pubs/rp/ StillDead02.pdf.
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