Feela

According to neoclassical theory, supply and demand of agents and firms set prices, but in general equalibrium models, perfect competition is used and in this an individual firm or agent has no affect on the market prices of inputs or outputs, so how the hell are prices set?

Kandahar

In a perfectly competitive market, no INDIVIDUAL can change the prices...but the market reaches an equilibrium on its own.

Let's say that I sell gasoline, and let's say that the gasoline market is perfectly competitive. There are always a certain number of people supplying a certain amount of gasoline, and a certain number of people demanding a certain amount of gasoline.

If I try to sell my gasoline for $2.01 when all other gas stations are selling it for $2, no one will buy gasoline from me in a perfectly competitive market. I will either go out of business, or lower my prices.

If I try to sell my gasoline for $1.99 when all other gas stations are selling it for $2, everyone will buy all of my gasoline and resell it for $2 in a perfectly competitive market. I would essentially be giving free money to my competitors. I will either go out of business, or raise my prices.

As an individual gas-seller, I don't have any say on how much it sells for. But nevertheless, the market reaches an equilibrium price on its own.

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Feela

Ahh but how does the market reach equilibrium if no agent can affect it?

Kandahar

All of them, collectively, affect it. But individually, none of them have any say. It's important to note that a perfectly competitive market is only a theoretical construct; it doesn't exist in the real world.

All real-world markets are, at best, imperfectly competitive...so individuals can and do have a very slight effect on the price.

Feela

That is impossible zero+zero= zero, if none of them can affect it individually they can't collectivally.
The truth is prices are set by Walras's auctioneer, if you have any faith left in neoclassical economics I suggest you look it up and see that last bits of faith evaporate as you realise the theory requires god(The auctioneer.) to set prices.

Walrasian auctioneer - Wikipedia, the free encyclopedia

Kandahar

That's why a truly free market is impossible. Although technically, each individual wouldn't actually be zero. It would just be an infinitesimally small amount of the whole. And .0001 + .0001 + ... + .0001 = 1. But even that would be an imperfectly competitive market.

Like I said, perfectly competitive markets are impossible in practice. How does that disprove the theories of neoclassical economics?

Feela

Because it is a fundamental part of general equilibrium theory and most of the other theories, there are also other gaping holes of course, like the impossibility of creating a smooth downward sloping market demand curve(without resorting to absurd assumptions.)and the demand curve could disect the supply curve at mulitple places, the fact that the supply curve, if it can be smoothly modelled , is constant or even downward sloping(Sraffa 1926.) and the cambridge capital controversy and linked research exploded the marginal productivity theory of distribution, and then of course there is Keynes.
The theory is in a shambles.

Steve Keen, the Post Keynesian economist, sums up well ,just the implications of Peiro Sraffa's destruction of diminishing marginal returns and the upward sloping demand curve.(note this has been proved by empirical tests which have shown over 90% of firms face constant or increasing returns.)


"Strange as it may seem . . . this is a very big deal. If marginal returns are constant rather than falling, then the neo-classical explanation of everything collapses. Not only can economic theory no longer explain how much a firm produces, it can explain nothing else.
"Take, for example, the economic theory of employment and wage determination . . . The theory asserts that the real wage is equivalent to the marginal product of labour . . . An employer will employ an additional worker if the amount the worker adds to output -- the worker's marginal product -- exceeds the real wage . . . [This] explains the economic predilection for blaming everything on wages being too high -- neo-classical economics can be summed up, as [John Kenneth] Galbraith once remarked, in the twin propositions that the poor don't work hard enough because they're paid too much, and the rich don't work hard enough because they're not paid enough . . .

"If in fact the output to employment relationship is relatively constant, then the neo-classical explanation for employment and output determination collapses. With a flat production function, the marginal product of labour will be constant, and it will never intersect the real wage. The output of the firm then can't be explained by the cost of employing labour. . . [This means that] neo-classical economics simply cannot explain anything: neither the level of employment, nor output, nor, ultimately, what determines the real wage . . .the entire edifice of economics collapses." [Debunking Economics, pp. 76-7]

Synch

Would you mind explaining it in your own words please? We can find quotes from different economists to counter each other all day but this debate is fruitless one doesn't understand the situation, would you mind elucidating what Keen(and others) said in your own words?

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Feela

Well in that quote he is just applying Sraffa's findings of constant or falling supply curves and marginal returns to the marginal productivity theory of distirubtion and the theory of wages in particular.
What happens is an employer will hire another worker as long as their marginal product is higher than or equal to the real wage, the marginal product is supposed to be falling so that at some point it will fall to the level of the real wage and profit is maximised and no more workers will be hired, but if it is constant or even increasing it will never intersect the real wage.(note this is acepting all the other parts of the theory like the market real wage is given etc).

Iriemon

I'm not sure what you are asserting here.

On the micro level, prices are dictated by the market as Kandahar suggests.

On the macro level, prices are set based upon aggregate supply and demand, depending upon the elasticity of supply and demand. Where supply exceeds demand, price will a function of cost. Where demand exceeds supply, price based upon the aggregate marginal demand for the product relative to the supply.

Are you suggesting that prices are not set by market but by other forces? What?

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