Profit under perfect competiton

[robbo203]

Hi all

 

I wonder if somebody could assist with a theoretical matter

 

Bizarre as it may ring in our ears,there is an argument which I think originated with the Swiss neo-classical economist  and  foremost proponent of general equilibrium  theory, L  Walras, that under a system of perfect market competition there can be no profit.  The opportunity to make profit arises only in an imperfect or distorted market.

 

 

The argument seems to be that in perfectly competitive market economy the capitalists will tend to increase their outlays on factors of production up until  the point where the marginal productivity of each factor is equal to its price  and the marginal cost of the product is equal to the price of said product.  That is when  profit is no longer forthcoming – because the difference between marginal cost and price is zero . O,r to put it differently,  any additional unit of output produced will not realize a profit. but will cost increasingly more than its worth

 

Have I got this right?  If so it seems to me to be a bit of crackpot theory.  I can sort of understand the logic of marginalist economic thinking and the difference between total utility and marginal utility.  The total utility of water is vast but the utility of the last unit of water is negligible because there is so much water around.  Contrariwise , to use Adam Smiths famous  water -diamond paradox , the total utility of diamonds is not very much but because the number of diamonds around is so small , the marginal utility or the utility of the last diamond that comes onto  the market is correspondingly great.  It is the marginal utility that determines the price in both cases according to marginalist theory

 

We can argue the toss about that but applying this logic to aforementioned question of profits does not seem to make any sense at all.  Profits don’t decline to zero as you approach this hypothetical point at which the marginal productivity of a factor of production approximates the price paid for it .  All it means surely is  that you get less profit out of each additional unit of that factor of production.  – your rate of profit declines but your absolute mass of profit still increases.  Certainly it will stop increasing when you reach the point when the price off the factor of production equals its marginal productivity and going  beyond that point will start to eat into this absolute mass so that eventually you may end up with no profit at all.  That would be when the total cost equals total income.  But that is very different from a situation in which marginal costs -the costs of an additional unit of some factor of production equals its productivity.

 

If capitalists made no profit under a system of perfect competition then the logic of this argument would suggests that it would be in the interests of capitalists to under-produce in relation to market demand so the prices they could command would be above the costs they had to bear.  Monopolies can  do this to an extent by restricting output and through price fixing .  But even if a system of perfect competition were achievable, how would  it be conceivable that profit would case to exist when  the very motive for investment would be to seek a return on your investment

 

Can anyone shed light  on what seems to be the very dubious logic that underlies this claim than under a system of perfect  competition there would be no profit?

 

 

Cheers

 

Robin

[DJP]

Not sure if you’re confusing profits with super profits?Don’t have my textbooks to hand right now. Is this what you’re talking about?It remains to be seen how you can achieve perfect competition in the real world.

[robbo203]

Hi Darren Well,  Im not talking about super-profits but profits but you might be on to something here…. I first came across this wacky idea in D R Steele’s From Marx to Mises  and wondered then  –  WTF is the  guy on about? How the hell can a business survive in  a competitive market environment  without profit. Unprofitable businesses go down the pan, don’t they?  Well apparently not according to Steele.  What is usually called profit  he calls “interest”.  Profit is something you get over and above interest and you get it by  outguessing the market and thereby benefiting society by an “unusually percipient  of lucky allocation  of resources”  (p420).  In a perfectly competitive market  – which as  you suggest is wholly unrealistic  – the opportunity for doing that disappears and hence also profit.  So profit according to this logic only arises in an imperfect or distorted market and the alleged benefits to society that such a profit entails which makes it sound  like Steele should be advocating imperfect and distorted markets it profit is so advantageous and beneficial to society… Where did this particular usage originate from? And what lies behind it I wonder? I know it crops up in Mises  but I think it also appears in  Walrus’ writings.  Does anyone have any ideas? Cheers R

[ALB]

DJP wrote:

Not sure if you’re confusing profits with super profits?

I don’t think Robin is but Walras and Steele certainly are. Both definitely meant the profits that accrue to firms because of some market condition over and above “normal” profits which they disguise under the name of “interest” (which is somehow mysteriously generated by fixed capital).Their definition is not followed by other bourgeois economists. For instance, here’s what Paul Samuelson writes in his widely-used textbook about the same imaginary situation envisaged by Walras where price (P) is exactly equal to long-run costs:

Quote:

Under such conditions of free “replication,” is it not obvious that long-run P cannot remain above this same critical breakeven point at which they all cover their long-run total costs—including in these(1) all labor, materials, equipment, tax and other expenses;(2) all wages payable to the identical managers at the level determined competitively by the bidding in all industries for people of such talents and industriousness; and(3) the interest yield that any of them could get on the amounts of capital that they tie up in this industry instead of investing it elsewhere?These “full competitive costs” are seen to include more than accountants usually include in costs: they include a normal return to management services, as determined competitively in all industries; and a normal return to capital as determined competitively everywhere by industries of equal riskiness. In the above sense we may say that “normal profits” are included in costs and that “excess profits” are competed away by entry and “abnormal losses” are eliminated by long-run exit of firms (Economics, 5th edition, pp.470-1).

Of course Walras’s “generalised equilibrium” is only a mathematical construct that is never realised and in fact never could be realised under capitalism, but despite this is considered by most bourgeois economists to be the normal state of capitalism. Capitalism in fact is in a permanent state of disequilibrium brought out precisely by firms seeking “super profits” and leading to recurring cycles of boom and slump.

[robbo203]

Hi Adam,Well, I’ve got the 10th edition of the same book by Samuelson and while he refers to the “dreamworld of perfect competition” (meaning he doesn’t think it at all realistic) he does go on to say that in such a dreamworld “the economist says there would really be no profits at all!”.  Also: “perfectly free entry of numerous competitors; would in a static world of perfect knowledge , bring price down to cost and squeeze out all profits above and beyond competitive wages , interest and rent” (p621-2).  I think this does actually accord with what Steele is saying. He (Steele) is not denying that perfect competition is impossible as far as I can ascertain; He is merely asserting that profits arise from, and are made possible by, the very imperfections that necessarily beset the market economy as it actually works in practice – .imperfections that allow some to outguess the market and others who are not similarly gifted with “entrepreneurial canniness” to fall by the wayside.  Profit is a zero sum game in other wordsIt should also be mentioned that the Misesian perspective that Steele presumably still adheres to is highly critical of Walrasian general equilibrium theory with its completely static view of the economy.If you check out  economic textbooks, a distinction is sometimes made between an accountant’s notion of profit and an economist’s notion of the same. The former boils down to the difference between a firms revenue and its costs. This is not that far removed from our understanding of the term although we would conceptualise profit as a component of surplus value alongside rent and interest.  Steele, and by extension bourgeois economists. would call what we call profit,” interest”My take on all this – though I am not entirely sure of this at all – is that this is an ideologically motivated construct. which entered economic discouse around the time oif the “marginalist revolution”of the late 19th century; to justify the return on capital in terms that denote something positive and beneficial to society as a whole – such as innovativeness and being able to anticipate shifts in market demand, the better to be able to “serve the needs of consumers ” etc etc” This is what this peculiar interpretation of profit is all about isn’t it? It presumes an imperfect market that rewards those who succeed in this market with “profit” . It is a way of highlighting those qualities that supposedly enable you to succeed and for which you “justifiably” reap the rewards of such successin the form of “profit” over and above “interest!Thats a curious thing too. “Interest” is the return on lending money – or liquid capital – and usually by financial institutions such as banks. By relabelling profit as interest this makes no distinction between external sources of funding (i.e.loans from a bank); and the reproduction of capital out of surplus value. Again, one has to ask – is this ideologically motivated to divert attention away from this latter source of capital?

[DJP]

A nice potted history of the rise of marginalist economics is in Ben Fine & Dimitris Milonakis ‘From Political Economy to Economics’But neo-classical economics is possibly on the way out, there’s a lot of text being produced within the field itself which criticize it and suggest a move to more ‘heterodox’ approaches. But as well as Marxian approaches this heterodoxy includes everything from Austrian economics to behavioral economics.My Open University textbooks for this year include a lot of hetrodux stuff, but no Marx.

[ALB]

In the 5th (1962) edition when discussing so-called “perfect competition” Samuelson does talk of “any positive profits (in excess of a ‘normal return’ on capital and labor invested) will in the long-run equilibrium be competed away” (p. 542) and of “the most perfect competition (where pure profit is zero)” (p.660). Perhaps this inconsistent distinction between “interest” and “profit” reflects a confusion in the minds of academic apologists for capitalism as to the best way to defend the income of the capitalist class.If they want to call profit “interest”, fair enough. But, in the present situation, where banks and “interest” have become a dirty word they may have backed a loser. Expect another change of emphasis in future editions of Samuelson’s Economics.I think this distinction goes back further than the “marginalist revolution in economics”. It’s also in Henry George’s Progress and Poverty (that I’ve been re-reading after getting into an argument with a Georgeist at Occupy St Pauls) which was first published in 1880. Here’s how he summarised the conclusion of Chapter 10 on “the laws of distribution”:

Quote:

Land, labor, and capital are the factors of production. Land includes all natural opportunities or forces. Labor includes all human exertion. Capital includes all wealth used to produce more wealth.The output is distributed in returns to these three factors. Rent is that part that goes to owners of land as payment for the use of natural opportunities. Wages are that part that constitutes the reward for human exertion. Interest is that part that constitutes the return for the use of capital.

In Chapter 13 entitled “False Interest” (but in the book edition I have “Of spurious capital and of profits often mistaken for Interest”) he says:

Quote:

Profits properly due to the elements of risk are also frequently mislabeled interest. Some people acquire wealth by taking chances in ventures where most suffer losses. There are many such forms of speculation, especially that method of gambling known as the stock market. Nerve, judgment, and possession of capital give an advantage. Also, those skills known as the arts of the confidence man. But, just as at a gaming table, whatever one person gains someone else must lose.Everyone knows the tyranny and greed with which capital, when concentrated in large amounts, is frequently wielded to corrupt, rob, and destroy. What I wish to call the reader’s attention to here is this:These profits should not be confused with the legitimate returns of capital as an agent of production. Any analysis will show that much of what is commonly confused with interest is really the result of the power of concentrated capital. For the most part, this should be attributed to bad legislation, blind adherence to ancient customs, and superstitious reverence for legal technicalities.Examine the great fortunes said to exemplify the accumulative power of capital: the Rothschilds, the Vanderbilts, the Astors. They have been built up, to a greater or lesser degree, by the means we have been reviewing — not by interest.

In other words, precisely the arguments employed by Steele, though George placed himself on the left, seeing “profits” as bad and arguing in the preface to the first edition that “laissez-faire (in its full true meaning) opens the way to a realisation of the noble dreams of socialism” !

[Author]

Posts