Comparison between Austrian and Post-Keynesian Criticisms to Neoclassical Theory - Essay Example

?Comparison between Austrian and Post-Keynesian Criticisms to Neo ical Theory I. Introduction The Neo ical economic school of thought has always been subjected under deep examination and scrutiny in the hands of several prominent economists. Among these critics are economists Israel Kirzner and Marc Lavoie, who are the major proponents of the Austrian and the Post-Keynesian alternative approaches, respectively. Apparently, the Neoclassical model was seen to have major issues with regards to the three basic assumptions of the model: (1) that people possess rational preferences over results that produce value, (2) that individuals are after of maximisation of utility while firms act in ways to maximise profits, and (3) that people are able to respond independently in accordance with a full and relevant information (Kirzner, 1997, p.61). Essentially, this paper would tackle about the problematic assumptions of the neoclassical model. Specifically, there will be a discussion on the different competitive processes described under the Neoclassical, Austrian, and Post-Keynesian approaches. There will also be a brief comparison between the Austrian and Post-Keynesian critics towards the neoclassical model, based on the different elements scrutinised by both Kirzner and Lavoie. Lastly, this paper will present the proposed alternative lines of thought of Kirzner and Lavoie, in their attempt to correct the mishaps created by the neoclassical model. II. Brief Overview of the Neoclassical Perspective The Neoclassical approach views the real world of market economies to be exactly representative of markets at equilibrium state. It assumes that the world mirrors the interrelationships present in equilibrium condition of the market. It also contends that the market is composed of agents whose maximisation desires fit each other’s wants (Kirzner, 1997, p.63). In other words, markets are expected to reach the equilibrium state in such a way that the interaction [between buyers and sellers] would push the market into the equilibrium price--sellers who are willing to trade their goods at or below the given price will be met by buyers who are willing to pay for such goods at or above the stated price. Therefore, the price is the sole indication that the market is not flawed. As long as the price lets demand and supply to intersect, the market will work efficiently. An additional assumption of the Neoclassical approach states that individuals and firms are expected to make rational decisions for their own benefit, so that individuals are expected to make decisions geared towards utility maximisation while firms are assumed to be always aiming for profit maximisation. Lastly, the Neoclassical model assumes that individuals and firms are given full relevant information about the market (Kirzner, 1997, p.63). With all these assumptions, it is not surprising to see economists who perceive the Neoclassical view as some kind of a classic utopia in economics. For some, it failed to account several important characteristics of a market economy. Economists also began to contest the utmost motive of both individuals and firms in the buy, sell, and trade of goods and services. Some of them proposed that firms and individuals are not inherently maximisation-seekers because they also have other ulterior motives in interacting with the market. Last and most importantly, economists start to go back to the question of equilibrium theory set in the neoclassical model. They continue to examine the elements built under this equilibrium model and attempts to invalidate the realism of the theoretical framework set in this assumption. III. Similarities between the Fundamental Characteristics of Austrian and Post-Keynesian Approaches The Fundamental Question on Neoclassical Theory on Markets’ State of Equilibrium Among this multitude of converging economists are Israel Kirzner and Marc Lavoie. Although each of them belongs to different schools of thought, both economists challenge the neoclassical perspective and its critical elements. In fact, the two economists share the main aim of presenting alternative views through which the firm achieves the point of equilibrium. Whereas the Neoclassical view passively assumes the state of equilibrium, both Austrian and Post-Keynesian proponents are determined to illustrate the processes and conditions that influence the equilibrating tendencies of the market. Individualistic View and Focus on Competition Secondly, Austrian and Post-Keynesian approaches are similar in that both theories focus on individualistic concerns. Contrary to the Neoclassical view that any market structure could be related to perfect competition, both alternative approaches suggest that firms are in pursuit of coming up with strategies that will help them achieve their own objectives. Apparently, competition (apart from perfect competition) prevails on both approaches. For Austrian view, to compete means engaging in entrepreneurial rivalry while for Post-Keynesian view, it means gaining dominance in the market (Kirzner, 1997, p.68; Lavoie, 1992, p.99). Objective of Firm--Not Profit Maximisation Thirdly, both approaches are similar as both argue that firms and individuals are not purely in pursuit of profit maximisation. According to the Neoclassical view, profit maximisation of firms is like the utility maximization of individuals, proven by a formula derivation that firm’s price-cost margin is equal to the inverse elasticity of demand; hence, profit equals utility. However, this was argued by the Austrian view by stating that entrepreneurs are not profit maximisers, for in the first place, the future for them is unknown (ECON30820 Business Economics II, Lecture Notes). Similarly, post Keynesians also do not assume firms are in pursuit of maximising profits, rather, they attempt to maximise growth. This would render firms more sustainability since growth maximisation contributes long run benefits compared to the short-ranged profit maximisation (Lavoie, 1992, pp.101-102). Imposition on Prices The entrepreneurial discovery approach of the Austrian view seeks to replace the notion on perfect competition with the idea of dynamic competition, wherein market participants are the ones pushing the price and quality offered in the market rather than merely accepting the level of price and quality the market wants to impose on them. In this perspective, uncertainty is pervasive, so that market processes are driven primarily by entrepreneurial activities. Activities done by entrepreneurs, in turn, are characterised by error—shortages and surpluses which may or may not mean profit opportunities to the entrepreneur. Sooner or later, the entrepreneurial activities taken as response to errors found will lead to change (Kirzner, 1997, p.71). This goes without saying that the competitive processes, for the Austrian view, are highly dynamic. One could expect that conditions are not stable--fluctuating from one state to another--simply termed as process dynamics (ECON30820 Business Economics II, Lecture Notes). In effect, firms impose monopolistic prices that cannot capture one single equilibrium state in the market, hence, not market-clearing prices. In a quite similar sense, the Post-Keynesians regard firms to be oligopolistic in nature, although the degree would vary from one market to another. Moreover, firms hold some degree of excess production capacity, which connotes that prices available in the market do not typically reflect market-clearing prices. Price, like in the Austrian view, is an administered, cost-of-production price, rather than the market-clearing mechanism demand—determined in terms of behavioral and income class habits corresponding to supply of firms through the change in their use of plant capacity (Lavoie, 1992, pp.97-98). In other words, the market-clearing mechanism of the market is not typical for the Post-Keynesian view. IV. Differences of the Fundamental Characteristics of Austrian and Post-Keynesian Approaches Difference on the Fundamental Basis of Competitive Process As mentioned earlier, the neoclassical view’s principal assumption is the state of equilibrium, which is contributed by the meeting of the price set by the buyers and sellers. It contends that this equilibrium promotes the so-called Pareto optimality, which enables firms to take on prices according to what the market dictates (ECON30820 Business Economics II, Lecture Notes). Since firms are for profit maximisation while individuals are for utility maximisation, it becomes logical to think that competitive processes are driven by utility maximisation and resource allocation. Ultimately, equilibrium is the ultimate product of optimisation. Entrepreneurial Discovery vs. Power-Motivated Nonetheless, this equilibrium theory is strongly refuted by the Austrian perspective. According to Kirzner (1997, p.61), the standard Neoclassical microeconomics, which centers on the Walrasian general equilibrium model, failed to present a realistic theoretical framework of the workings in market economies. This stems from two major issues in the model: (1) the basic assumption that the market is in the equilibrium state by default (2) the lack of relevance for failing to take into account a non-equilibrium state of the market. With this, Kirzner (1997, pp.61-62) contends that it should show the transition of the market, starting from its initial state of non-equilibrium until such time when it starts to show signs of equilibrating tendencies. Kirzner further asserts that equilibration should be a systematic process through which market participants gain better, more relevant, and more accurate mutual knowledge of potential demand and supply behavior. According to him, it starts with the driving force that compels this systematic process, which he referred to as the entrepreneurial discovery (Kirzner, 1997, p.62). Coupled with an element of surprise, the discovery approach reduces the occurrence of imperfect information or the so-called sheer ignorance. This translates to increasing mutual awareness among the market participants, which in turn, drives prices, output, and input qualities and quantities until finally reaching the state of equilibrium (Kirzner, 1997, pp.62-63). In the end, this systematic process leans towards the equilibrium state. The Post-Keynesian view, on the other hand, uses power as the fundamental basis of market competitive processes. According to Lavoie (1992, p.99), firms are not after of maximising profits, rather, it uses gained profits as a means to attain multi-purpose objectives. Post-Keynesians believe that a firm is a multi-faceted entity, which attempts to gain power, may it be over the environment, the economic, social, or political sectors. The reason for this objective is the desire to control sectors in the society including its material suppliers, customers, government, and technology. Moreover, power also increases the size of the firm, which is very relevant to the firm as it means larger influence in the setting of prices and costs. This is when growth starts to subside in the company, which upholds its preeminence and survival (Lavoie, 1992, pp.99-101). Fundamental Uncertainty vs. Procedural Rationality It could be recalled that neoclassical theory expects the agents of the market processes to be rational in their decisions. As a result, everything that matters about the future is included in the present. This is one aspect criticised by both Austrian and Post-Keynesian perspectives, although the two are found to be in split views when it comes to the assumption of the behavior of market agents. Whereas in the former, agents act in situations of fundamental uncertainty, the latter suggests that agents act in a so-called procedural rationality—courses of actions that follow procedural steps (Lavoie, 199, p.106). Essentially, Austrian view adheres to the prevailing uncertainty of the future, which allows agents only to the extent of engaging “purposeful action” or in making “qualitative judgments (Kirzner, 1997, pp.69-70). Post-Keynesians, on the other hand, do not submit directly to uncertainty; agents attempt to evaluate conditions given available and relevant factual information first. If there is none, agents by then would have to consider the standards followed in the market (Lavoie, 1992, p.106). Prediction vs. Explanation Standard theory could state future phenomenon even though given only the present conditions. In both market and individual level, there is no room for imagination and creativity for the players of the market. This is countered by Austrian view, which looks into an uncertain, yet imaginable, future (Kirzner, 1997, p.67). Basically, agents acknowledge that there are elements in the market that are yet to be known. Post-Keynesians, in contrast, would avoid uncertainty since it could cause unnecessary problems and diversion from a firm’s aim of power. They are likely to favor explanation rather than merely prediction of the future (Lavoie, 1992, p.99). IV. Conclusion After careful scrutiny and examination on the assumptions set by the neoclassical theory, it is evident that there are still some areas that need to be improved through clearer articulation or, better yet, restructure on its assumptions. Certainly, the Austrian and Post-Keynesian perspectives cannot be ignored for both theories provide strong arguments and queries as to how competitive processes work in the market. Apparently, both views also provide quite extensive criticisms on almost every major aspect of the mainstream theory; criticisms, which could also be proven useful to a more improved understanding of how markets work. However, one should be mindful that these criticisms are also subject under another set of criticisms. In fact, even Austrian and Post-Keynesian perspectives signal divergence with one another, despite being united in specifically condemning the equilibrium theory of the neoclassical view. This goes without saying that, in the face of emerging criticisms like these two, economists must continue to examine their validity and to seek improvement in the flaws of the standard theory, thereby improving the quality of market analysis. References Kirzner, I.M., 1997. Entrepreneurial discovery and the competitive market process: an Austrian approach. Journal of Economic Literature, 35 (1), pp.60-85. Lavoie, M., 1992. Chapter 3: Theory of the firm. In Foundations of Post Keynesian Economic analysis. Aldershot: Edward Elgar Publishing, pp.94-148. Read More