The Post-Keynesian economics appreciates the importance of the effective demand principle in the short and long run economic adjustments towards full employment. Led by Paul Davidson and Hyman Minsky, the Post-Keynesian economics has positive contributions towards overall economics growth in the world. Their basis goes beyond the theory of aggregate employment to other theories like theory of income, trade, growth, distribution and development and critically observes how demand affects them. The Post-Keynesian economics also emphasized on how demand for bank credit affects money supply in the monetary theory field.
Also incorporated in the monetary policy is the effects of the interest rates in the demand and supply of money rather than the earlier emphasis on quantity of money alone. This paper will seek to analyze the significance of Post-Keynesian theory and some of the Austrian criticisms on the neoclassical view of competition.
Significance of the Post-Keynesian theory
The theory acts as a basis from which economics fundamentals are derived. For instance, the shape of the short-run cost curve can be proven by the Post-Keynesian facts. The general decreasing tendency of the average cost, the constant trend adopted by the average variable cost and the firm’s tendency to produce at reserved capacity level are the three major facts, which support the U-shaped short-run cost curve.
According the Post-Keynesian theory, though it is essential to consider the impacts of technology in the firm’s production, the substitutability of innovation and technology cannot be possible in the short-run. In addition, they argue that the machines operate through the help and coordination of the engineers and in most cases, they ought to follow the entrenched bureaucratic rules which the management has put in place to govern the firms’ activities (Lavoie, 1992, p. 118 &119).
The Post-Keynesian economists also argued that the firms play a very big role in price determination. According to Lavoie (1992 p. 98), the firms are said to consider the administration, production and marketing costs to determine the market prices of goods and services. There is therefore a price determination regime in firms, which assists in setting the market prices of goods and services in the market. Moreover, the size and the production capacity of the firm are significant whenever the issues of price determination arise.
The Post-Keynesian theory of economics showed how demand affects the supply and price determinations of goods and services in the market. Their economic principle suggest that consumer needs and desires go hand-in-hand with their purchasing power and that it is through this that the prices of goods and services in the market are determined. They further defined that the market determination also follows the market economy model, which argues that the economy is based on division of labor. In this case, the supply and demand forces in the market freely determine the prices of goods and services.
However, the free market adjustments only take place in the free market economy where there is free entry and free exit of firms in and out of the market without any restrictions. Alternatively, there are some countries, which play a significant role in price determinations, and in this case, those states operate on a planned economy system. In such economies, the government set the minimum and the maximum prices of goods and services in which the firms are obligated to follow. The maximum price set by the government is also known as the price ceiling while the minimum price is also referred to as the price floor.
The planned economy is mostly found in communist system of government like in china before 1978 and India before 1991. This form of economy still prevails in some countries like Cuba, Iran, Korea and Libya.
Since the Post-Keynesian theory emerged when the most of the firms were characterized by monopolistic nature, the basis has evolved to accommodate the modern nature of firms in the market. The oligopolistic and the monopolistic nature of the firms which were used to derive major theories in the Post-Keynesian theory therefore restrict their operation in the modern world. This is because the competitive nature of firms and industries immensely characterize the modern economic operations. During that time, it was easier for the firms and industries to collude in price determinations since they were in full control of the market.
Nevertheless, the resent evolution of economy to accommodate competition in the market has made it hard for the few firms to set prices as it can adversely affect their profits. We can therefore say that the cost-plus pricing mechanism can only be applicable to the monopolies and oligopolies. However, the cost-plus pricing technique is still used in the car and computer industries in the various economies across the world. The technique is also applicable in some retail trades and more so where the large or big firms do not dominate (Lavoie, 1992, p. 95 &96).
The Post-Keynesian also justifies inflation target-based interest rate policy. This policy is similar to that of the conventional monetary policy though there is some partial difference in applications. It is also recommended to uniquely adjust the balance sheet since there is some major difficulty in controlling and regulating money supply in the market. There is therefore a great need of adjusting the balance sheet regulation into an asset based reserve requirement in order to cater for the interest rate factor (Gnos & Rochon, p. 94).
The Austrian criticisms of the standard neoclassical view of competition
According to Kirzner (1997 p. 61), the competitive model fails to explain the market phenomena instantaneously and instead majors on addressing only the equilibrium market phenomena. The competitive model therefore ignores other important economic factors, which affect the market operations from one instance to another. The neoclassical view is therefore regarded as a utopian argument, which tries to assume that perfect market can exist in an economy. There is therefore a normative bias since the actual economics activities are not taken into consideration.
The neoclassical view on competition is based on assumption that individuals will always act rationally when given the freedom to make decisions in the market. However, this is not the case considering the human nature of being an economic being. According to Krizner (1997, p. 63), the individual entrepreneurial nature may result to market injustices where only an establishment of a body to restore order can help. It is important to understand that self-centeredness still dominates the human nature and for this reason, unworthy competitiveness is brought about in the market.
As a result, some individuals end up exploiting the consumers of goods and services through charging them higher prices. In addition, because the government will have left the market to adjust itself automatically, firms and industries might take this chance to hike prices of their goods and services. The firms may also collude among each other – as it is mostly seen in the oil industries – to fix price, which maximizes their wealth without considerations of the public interests. Whenever the large cartels come closer to the neoclassical ideal of wealth maximization, there is a tendency of ignoring the wider social issues in a country. The neoclassical view on competition is therefore descriptive instead of being normative and seeks to address more of the private issues at the expense of social utility (Marginson, 1997, p. 235&236).
The neoclassical theorists are also said to focus more on mathematical and other complex models in their explanations. The mathematical view in most cases fails to capture the actual market behavior since some variables cannot be actualized to the real values in the economy. Milton Friedman though has stood against this criticism arguing that theories should be judged not on their realistic nature but on their ability to prove and predict economic events. In this case, competition cannot be monetary valued and therefore the use of mathematical formulations will hardly be applicable. On the other hand, a certain firm can study the performance of another firm and position itself well to outshine it in the market.
The neoclassical view also assumes a complete mutual knowledge of market among the plays, which is not always the case. The Austrian seems to be dissatisfied since the market participants seems to be restrained to compete in their daily market operations. Their grievances stemmed from their unwillingness to surrender their economic behaviors and embrace the new market equilibrium models, which are active in the current world.
The Austrians also see the competition theory as unrealistic in the sense that it fails to address the real market outcomes, which satisfy the conditions of equilibrium. The model is also accused of not being open-ended and therefore it discourages creativity and innovation among the key players. The complete denial of creativity denies people on designing some profitable and more effective measures towards improving the general economy in the country (Krizner, 1997, p. 64).
No model that is developed in economics is flawless. Some factors considered in some models are ignored in other models, which make the models incomplete and only have meaning under certain circumstances. Neoclassical economics has been mainly criticized due to its normative bias. This means that the neoclassical economics does not reflect a true picture of the actual economy but describes a situation of utopia of Pareto optimality. The model has various assumptions, which make it ineffective and unrealistic according to its critics. These assumptions include the tendency of the models to focus on individuals in the economy which may lead to analysis being obscure on issues that are long term e.g. the desirability and stability of the economy that has limitations of natural capital.
It also assumes the rationality of individuals. This is ignorance on the issue of human behavior. There is a huge gap between the “economic man” and the “real earth man”. The model can most likely fit to large corporations since they represent a perfect example of profit maximization though it may not suit the situations where social issues are ignored.
Indeed, combining the neoclassical economic models to an economy, which takes time to develop and has capital goods, is one of the major problems (DeMartino, 2000, p. 112&113).
The models have been found to be wanting and their use should be limited since they can make economists make wrong inferences to the economy. These models such as; the mathematics model, game theory, linear programming and econometrics have been used time and time again yet they may be misleading (Cook, 2004, p. 67).
These models are mainly based on complex mathematical models, which should not be the case. These complex mathematical models do not actually describe the concept of a real economy making them unrealistic and not applicable. The models have also been seen to copy mechanics used in the earlier 19th century. They assume key factors in the current generation of globalization such as; human creativity and complexity of nature and rely on equilibrium.
The role of the Post-Keynesian school of economists cannot be under estimated since they have helped other economic views to emerge from their ideals. It is therefore very important to appreciate their role in the world economy as they initiated some theories in the economy. In addition, the upcoming economic theorists should understand that the economic level during that time limited the Post-Keynesian theorist in their work. This is considering the fact that competition was not vivid although it has come to dominate in the current markets. Some adjustments therefore need to be done to some of their work in order to address the modern economic changes that are emerging day-by-day.
Despite the fact that Austrians tend to differ with the neoclassical view on competition, they should embrace the economic changes such as free market. This is because by so doing, market forces will be left to determine most of the important variables in the market such as price. The free market adoption will also encourage emergence of new firms and industries, which will boost the economic growth in the country. Nevertheless, it is still very important to have a regulation body, which will help in checking the cruel and other unfair competition between firms.
Cook, P., 2004. Leading issues in competition, regulation, and development. Massachusetts, Edward Elgar Publishing. Web.
DeMartino, G., 2000. Global Economy, Global Justice: Theoretical Objections and Policy Alternatives to Neoliberalism. New York, Routledge. Web.
Gnos, C. & Rochon, L. P. (2006). Post-Keynesian principles of economic policy. Massachusetts, Edward Elgar Publishing. Web.
Krizner, I. M., 1997. Entrepreneurial Discovery. Journal of Economic Literature, vol, 35.
Lavoie, M., 1992. Foundations of post-Keynesian economic analysis. Hague, E. Elgar.
Marginson, S., 1997. Educating Australia: government, economy, and citizen since 1960. Boston, Cambridge University Press. Web.