Against "perfect competition"

On the comment thread of a post by David Henderson, Don Boudreaux shares a great blurb for Alan Manning's book "Monopsony in Motion" that drives home an important point:

"What happens if an employer cuts wages by one cent? Much of labor economics is built on the assumption that all the workers will quit immediately. Here, Alan Manning mounts a systematic challenge to the standard model of perfect competition. Monopsony in Motion stands apart by analyzing labor markets from the real-world perspective that employers have significant market (or monopsony) power over their workers. Arguing that this power derives from frictions in the labor market that make it time-consuming and costly for workers to change jobs, Manning re-examines much of labor economics based on this alternative and equally plausible assumption."

If you've read the book, you know that Manning hits this idea of perfect competition hard in the first chapter, pointing out how broad the use of it is in textbook economics and how little time is spent with monopsony cases (of course, quite a bit more time is spent with monopoly - he's thinking in terms of labor texts).

The conversation with Don has been confusing to say the least. On David's thread he was reading this as Manning criticizing markets. At the time that struck me as Don confusing blackboard perfect competition with markets, and I told him as much. Now he's got a post on his own blog saying precisely the opposite - contrasting perfect competition with market competition in the real world.

So now he seems on board with Manning and me, but he still seems to think he's not on board.

So I'm hopelessly confused by Don now, but the fact remains that it's critical to draw this distinction between perfect competition like you learn in Econ 101 and market competition, which is full of frictions and irregularities and which unfolds over time as a part of a process of social interaction. In the market you are always dealing with a lot of market power - monopolistic and monopsonistic. Entrepreneurs (among employers and employees, I should emphasize) spend their time doing two things - (1.) figuring out how to compete away the market power of others, and (2.) figuring out how to gin up some market power for themselves. Any time you do something to make yourself indispensable you're generating market power for yourself. You have monopoly rents over what you have to offer, to say nothing of the power over the information about yourself in your brain. And we use that power all the time in the real world.

So the real world is very much Alan Manning's world. Markets are a process where people figure things out and develop new advantages for themselves. It's not textbook perfect competition.

The best that can be said for perfect competition is that it can offer a useful simplification in a bigger model in some cases. Old Keynesian theory worked that way. It used perfect competition assumptions because it was easy, others were assuming it, and the focus was elsewhere. Both Post Keynesian and New Keynesian analysis has dropped those assumptions because we can do better. But the assumptions served their purpose for a time (and they're still useful when you're introducing people to Keynesian ideas). There are presumably other examples like this.

But never mistake the occasional pedagogical value of perfect competition for a picture of the real world.