PERFECT COMPETITION AND THE TRANSFORMATION OF ECONOMICS
Frank M. Machovec
Routledge, 1995. xi + 391 pgs.
Doctoral dissertations seldom make good books. Even the most trivial assertion in a thesis
be footnoted; and the author, much to the reader's discomfort, must demonstrate his control of his
subject in excruciating detail. But occasionally, the virtues of the form triumph over its
limitations; and Frank Machovec's excellent work is one of these happy exceptions. His
extraordinarily thorough research illuminates many areas of economics.
Machovec's choice of topic manifests his courage. The mathematical formalism favored by
Walras has come to dominate modern economics. Elaborate models of perfect competition are
the prime topic of contemporary microeconomics; and newcomers to the subject often think that
they have walked by mistake into a seminar of the mathematics department.
Like other Austrians before him, Machovec contends that models of perfect competition do
adequately account for the characteristic features of competition in the real world. Our author is
not an Austrian of the strictest observance, and he does not renounce the use of these models
altogether. "As one who holds undergraduate degrees in mathematics and meteorology, I am an
equivocal supporter of the value of formalism in economics. I fully concur with Jevons's
observation that, in a discipline devoted to the study of small marginal effects, the widespread
employment of calculus is inescapable" (p. 9). But the dominant theme of his book is not the
benefits of formal models, but their limitations.
When formalists face attack, they are liable to respond with derision. "Who are you," they
say, "to challenge the way economics is done? If you do not like our mathematics, found your
own discipline." Machovec neatly turns the flank of this rejoinder. The mathematical economists
are themselves interlopers. They falsely contend that their models develop the insights of the
great classical economists of the nineteenth century. In fact, our author contends, they do not do
so: formalistic analysis neglects the process approach to competition favored by the classicals.
The Austrian critics of perfect competition, not its latter-day proponents, carry on the study of
economics as it has been historically conceived.
But what exactly is wrong with mathematical models? For one thing, they assume that the
price cannot be changed by the actions of an individual producer: prices are parametric. Further,
individuals operate with perfect information. "Since Knightian perfect competition assumes
perfect knowledge by all producers and consumers, a market populated solely by price- taking
firms will have only one price charged to all buyers" (pp. 101-102). And of course if the law of
one price obtains, mathematical analysis gains a firm foothold.
Machovec's argument must confront an objection. Perhaps, it will be claimed, the models of
days rested on overly restrictive assumptions; but we have overcome all that. Do we not now
have models that allow for imperfect information?
Our author is not to be put off this easily. These models, he contends, fail to take account of
genuine uncertainty. "The equilibrium theorist assumes that the decision-maker is already
in the right field, whereas the process theorist emphasizes that recognizing the appropriate place
to start digging is the big hurdle. In equilibrium theory, the probabilistic outline of the unknowns
is already known, thereby enabling a Stiglerian marginal benefit, marginal cost analysis to reap
an optimal outcome. Equilibrium theory simply cannot address the real problem: where to search
and what to search for" (p. 171).
This response gives rise to a new objection. What if the mathematical economist says: All
we do use unrealistic assumptions. So what? They work. Have you never read Friedman's "The
Methodology of Positive Economics?"
Machovec directly confronts this counterargument, and to my mind his answer is the best
of the book. He shows that adoption of the mathematical model leads to serious mistakes,
especially when the model is taken as a welfare ideal by which to judge the actually existing
Our author's account of the socialist calculation debate impresses me as especially insightful.
When Ludwig von Mises demonstrated in 1920 that a socialist economy could not rationally
allocate production goods, he left socialists in disarray. What were they to do? Oskar Lange, a
Marxist who was also a leading neoclassical theorist, found what he took to be an escape.
Whatever the market could do, so could socialist planners: they had merely to allow the
managers of socialist enterprises to compete for resources. "Lange concluded that the problem of
socialist calculation can be solved, theoretically, through a series of trial-and-error prices.
Producers react to shortages (or surpluses) by raising (or lowering) their prices until general
equilibrium is reached" (p. 53). Mises, in Lange's view, was hoist with his own petard: his
demonstration that the market worked efficiently by that very fact showed that socialism also is
efficient. The equations of equilibrium are the same in both systems. Lange's argument won over
most of the economics profession, until the collapse of communism made it clear that Mises was
What blinded so many eminent economists for so long to the validity of Mises's argument?
our author, the culprit is equilibrium analysis. Wrongly taking the perfect competition model to
be a picture of an economy as it ideally ought to work, economists saw no reason a socialist
system could not allocate resources according to the model's requirements. Had they grasped
for actors in the market, uncertainty is rampant, they would have realized that their models of
efficient socialism were useless.
Machovec uncovers a surprising fact about the debate over Lange's model. One of Lange's
sharpest critics was Maurice Dobb, a Cambridge University economist who was a committed
Communist. Lange's system allowed considerable governmental redistribution of income; and
here Dobb found a fatal flaw. "By moving toward a more equal distribution of income, the
socialist state buys more equality only by inducing inefficiency. This wrote Dobb, 'is the central
dilemma' faced by socialism" (p. 54). I hasten to add that Dobb did not agree with Mises that
socialism was inefficient. He favored full-scale central planning and failed to confront Mises's
argument at all.
Our author devotes considerable attention to showing that economists before the
revolution had a much more accurate conception than their successors of how the market works.
They realized that, in a world of uncertainty, the entrepreneur's role is vital. Prosperity depends
on enterprisers whose judgment enables them to anticipate the wishes of consumers and shift
resources accordingly. The linchpin of the economic system is that information is not perfect.
Among the nineteenth-century figures who clearly saw this, I was surprised to learn, was
Bentham. "Every thing which is routine today was originally a project...; and when new, it was
the production of that mischievous and bold race...of projectors [Bentham's term for
entrepreneurs]!" (p. 115, quoting Bentham).
Bentham's views, though innovative, were by no means anomalous in the nineteenth century,
Machovec abundantly shows. But readers who wish to study the historical details should consult
the book directly. I found especially valuable Alfred Marshall's warning against too much
reliance on static models (p. 243).
Inevitably, at least when I am the reviewer, a few details arouse misgiving. While Machovec
conclusively shown the falsity "of the neoclassical claim that the classical theory of the market
was entrepreneurless" (p. 2), he has not shown false the claim that mathematical models
formalize particular aspects of the classical view. I doubt that his claim that Bakunin was
influenced by "the practices of early communal Christians" is correct (p. 327, n. 12). He seems to
me to allow too much scope for the state to regulate monopoly (p. 303). And the claim that "[I]f I
already know the consequences of each available course of action open to me, then the ultimate
path is, in effect, given, not chosen" (p. 72) seems dubious. To know that something will happen
does not fix how one values it.
I'm sorry I had to insert that last paragraph. The remarks in it do not detract from the fact that
Machovec has made an outstanding contribution to economics.