The Monopolistic Competition Revolution and Business as Usual Thereafter

Table of Contents

Introduction

Philosophy Science – A Brief Overview

Kuhn – Paradigms Revisited

Problems In Modern Microeconomics
The Monopolistic Competition “Revolution”
The Revolution That Wasn’t

Conclusion

Reference list

Introduction

“Resistance is futile - you will be assimilated” ¹

(Star Trek)

Like many of the social sciences, economics grew out of philosophy. Philosophical reflections on the “scientific method”, on the nature of rationality, and on societal welfare are of vital significance to economists. These reflections on economics are ancient, but the conception of 'the economy' as a field of scientific interest originated only in the 18th century. Aristotle addresses some problems of economics mainly as problems of household management. With the increasing importance of trade and of nation-states in the early modern period, 'mercantilist' philosophers pondered upon the predecessors of modern macroeconomics. As late as in the work of Adam Smith does the economy appears as an object of study with its own principles and laws. Much of 18th-century philosophy of science was influenced by Newtonian physics. It then lay to Adam Smith to extend such a method to a systematic Inquiry into the Nature and Causes of the Wealth of Nations. In the late nineteenth century, neo-classical economics developed, mainly in Europe. It is still regarded as the mainstream of economic thinking and has revived in recent years with the decline in emphasis on Marxist and Keynesian concepts. Economists who led the 'neo-classical revolution' did not reject classical economics, with its emphasis on the efficiency of markets in allocating resources. The logic of neo-classical economics is mainly deductive - once the assumption of maximization (of profit, sales, output or any other outcome) is adopted, the implications are theoretically irrefutable (www.thomsonlearning.co.uk). Criticisms of neoclassical economics relate mainly to the excessive simplicity of the initial assumptions and/or to the impractical complexity of the derived implications for business decisions.

Beginning in the 1930s, mainstream economists began to have a bad conscience about their traditional methodology, which some saw as insufficiently empiricist. Other economists cited survey data to argue that the theoretical propositions of economics were false. The theory of monopolistic competition was in the middle of this phase that Kuhn would have termed scientific crisis. In this paper the emphasis is on the fact that it did not grow to become the scientific revolutions that Kuhn predicted for these times of methodological uncertainty. The confusing methodological situation stabilized in the 1950s.

In section 1 I try to give a brief overview of philosophy of science. It can obviously not be exhaustive rather it is supposed to set the stage for the succeeding analysis. In section 2 I will narrow the focus down to the works of Thomas Kuhn. In section 3 Kuhn’s conclusions and prediction are tested on a case study. In the 1930s, mainstream economics, and microeconomics in particular was pressured by the gap between its predictions and the real world’s markets notably in the United States. The concept of monopolistic competition forwarded by Chamberlin set out to challenge mainstream economics by adhering to the empirical observation of imperfectly competitive markets as its equilibrium ideal. In the conclusion, by trying to explain the attempted revolution with Kuhn’s terminology I attempt to establish how it has seemingly escaped Kuhn’s prediction of scientific revolution.

Philosophy Science – A Brief Overview

Modern science was born in the early 17th century when the strategy of taking the facts of observation seriously as the basis for science was first seriously adopted. Empiricism and positivism share the common view that scientific knowledge should in some way be derived from the facts arrived by observation. Facts were thought to be directly given to careful, unprejudiced observers via the senses, prior to and independent of theory, and constituting a firm and reliable foundation for scientific knowledge. Criticism was leveled at this arguing that observation statements presuppose knowledge, so it cannot be the case that we first establish the facts and then derive our knowledge from them. Chalmers (1997) argues however that the idea that knowledge should be based on facts that are confirmed by observation is not undermined by the recognition that the formulation of the statements describing those facts is knowledge-dependent. If the truth or falsity of observation statements can be established in a direct way by observation, then, irrespective of the way in which those statements can be formulated, it would seem that the observation statements confirmed in this way provide us with a significant factual basis for scientific knowledge.

Then, by means of induction it is possible to argue from a finite number of observations of facts to establish a general statement. The difficulty is to select the relevant facts for the conception of a theory. Devastating criticism came in the form of the circularity argument in inductivism². Lastly, it remains that the method of inductivism can only lead to probable truths. These however, are, after the qualifications, as objective, reliable, predictive and explanatory as possible. General statements, whether or not arrived at with induction, form the starting point for deduction. Deduction adheres to logical development of arguments. In them however lies not necessarily truth as they cannot remedy or even identify false general statements.

Thomas Kuhn’s theory of paradigms and scientific revolution will be presented in more detail in the next section. I conclude the overview of philosophy of science with Imre Lakatos' methodology of scientific research programs (which represented a wedding of some of Thomas Kuhn's insights to Popper's philosophy of science) was for a while widely discussed. Although still emphasizing the importance of empirical criticism, Lakatos insisted that theories should not be abandoned until superior alternatives are found. In the 1970s and 1980s other streams of contemporary philosophy of science began to influence the methodological reflections of economists. According to Karl Popper, the hallmark of science is to formulate theories so that they can be exposed to empirical testing and to reject theories that fail tests.

Kuhn – Paradigms Revisited

According to Thomas Kuhn, science, rather than providing a steady accumulation of knowledge which brings us ever closer to truth, develops more along the lines of a series of revolutionary changes (punctuated by peaceful eras which he calls “normal science”) during which the world view of the science is replaced by an entirely different one. The scientific community determines which theories will be accepted and which rejected, it enforces (if needed) the acceptance of the current dominant theory (paradigm) and it determines (or at least accepts) when it is time for a theory change. Because two paradigms are essentially incommensurable, only a revolution can provide the conceptual leap from one framework to another. Between revolution, periods of calm (normal science) display more of a cumulative development of knowledge, and these times are spent predominantly resolving the problems (puzzles) left over from the revolution. The general prediction is however that always some puzzles will resist resolution and may eventually lead to a crisis and a new revolution.

A paradigm is an accepted model or pattern, but also encompasses a theoretical structure, which includes a network of conceptual, theoretical, instrumental and methodological commitments. Paradigms are scientific achievements, they have universal status and they give a model to guide scientific (empirical) endeavour. The paradigm is the source of methods, theoretical and practical commitments and standards of solution accepted by scientific community. The main function of a paradigm is to achieve conformity of the paradigm community to the basic worldview; that is, once a paradigm is accepted, the paradigm community actively seeks not to find criticisms, contradictions, or novelties; indeed it seeks to suppress competing views. Any “new” paradigm must provide a ‘better‘ explanatory framework than its competitors, that is it must offer’better’ explanations for known problems in the field.

Kuhn acknowledges that any given paradigm will not explain all phenomena; indeed he states that it need not. “To be accepted as a paradigm, a theory must seem better than its competitors, but it need not, and in fact never does, explain all the facts with which it can be confronted” (Kuhn, 1962: 17-18). While a paradigm is or at least includes, “some implicit body of intertwined theoretical and methodological belief that permits selection, evaluation, and criticism” (Kuhn, 1962: 16-17), it is also the source of methods, problem-fields, and standards of solution accepted by a scientific community and is the prerequisite to the discovery of scientific laws. Even what counts as a fact is determined by the paradigm. Switching paradigm then, it seems, is a substantial disruption. Indeed, paradigm changes entail changes in the global perspectives, in the standards, governing rules, laws, problems, concepts and explanations of science. Such change is so radical that a paradigm is understood to be incommensurable with its predecessor, i.e. according to Kuhn, there is no method by which they can be (adequately) compared for the purpose of making rational theory decisions. To avoid such ruptures, the aim of the scientific community, as mentioned above, is conformity to the basic worldview of the paradigm, not novelty or surprise. However, a paradigm must have sufficient room to incorporate new discoveries for that is crucial to the survival of the paradigm. If on the other hand the paradigm is too precise and far-reaching, it is a more sensitive indicator of anomaly and hence occasions for paradigm change.

During the periods of normal science any research is carried out within the framework of the accepted and functioning paradigm. Normal science does not aim to find or cope with unsuspected phenomena, novelties or anomalies, rather it seeks to suppress competing viewpoints in order to continually secure and develop the dominance of the paradigm. Hence, paradigm science prospers, says Kuhn, when novel theories and crises are rare. Only in times of crisis do debates over fundamental issues, philosophy, epistemology, new ideas, and questioning pf the paradigm, play a role. The stability of the normal science and the universal acceptance of the ruling paradigm ensure that any successful, well-entrenched paradigm is almost impossible to overturn! The paradigm is well protected but there arise anomalies, which may become crises.

If anomalies cannot be resolved, they are either brushed aside or given ad hoc explanations within the terms of the paradigm. Some anomalies, however, persist. Eventually the pressure builds up to a point where the paradigm as a whole is called into question. The revolution commences with a period of crisis. At first, the adherents of the “old” paradigm will defend it vigorously and find it difficult to be persuaded of the breakdown of their paradigm, let alone the merits of the competing paradigm. But a time comes when the problems and difficulties encountered undermine the framework provided by the paradigm; if this persists a crisis of confidence is generated, leading to the ultimate breakdown of the dominant paradigm.

The transitional phase identified by Kuhn must have crisis and availability of an alternative must coinciding. The decision to abandon the old model is simultaneous with the decision to accept the new one. The period of crisis and transition is marked by a proliferation of competing articulations, willingness to try out new ideas, recourse to philosophical debate over the fundamentals of the field, all of which are symptoms of the transition from normal to extraordinary research. In effect, the rules of normal science are loosened and scientists try out different ideas. As each [alternate framework] seeks the allegiance of the entire professional community, a struggle ensues between subgroups committed to alternative paradigm candidates, each of which “governs in the first instance, not a subject matter but rather a group of practitioners”. (Kuhn 1962: 180) To resolve the crisis, the basic conceptions of the discipline require reanalysing. There is renewed attention to the fundamentals of the field and to its philosophical foundations. Thus, a paradigm shift comes to be seen as a “reconstruction of the field from new fundamentals, a reconstruction that changes some of the field’s most elementary theoretical generalisations” (Kuhn 1962: 85)

The weakness of any contending new paradigm is getting the community to accept the need for a new paradigm. That sets the stage (“arena”) for psychological and sociological phenomena. Tipping the scientific community to one side or the other involves such profane ideas as “group think“ or herd-behaviour. Obviously, rational debate between paradigms is thus impossible, for each paradigm contains its own standards at all levels. Paradigm choice is not, indeed cannot be, determined by rules of reason and logic because at issue are the very rules themselves³. Thus the choice between competing paradigms “cannot be made logically or even probabilistically compelling for those who refuse to step into the circle […].” (Kuhn 1962: 94) Allegiance to a paradigm, Kuhn emphasizes, is gained primarily through a variety of sociological and psychological factors, rather than logical argument.

Finally, the adoption of a new paradigm (Kuhn’s gestalt switches) is one-way changes: they cannot be reversed, they occur all at once or not at all. If sufficient numbers of scientists switch allegiance to the new theory, then it becomes the new normal science. Dissenters are excluded from the scientific community and eventually die out.

The above summary yields quite a coherent theory of scientific development and change. Its shortcoming however is that it is not always borne out so neatly by reality as history has shown. By means of an example I want to question the predictive power of Kuhn’s theory of scientific revolution. I anticipate criticism along the lines that the challenging paradigm was not yet strong enough to set in motion the process outlined by Kuhn, but counter argue with later developments of and empirical evidence about how the challenging paradigm’s theories were integrated and thus seized to pose a threat to the dominant paradigm and by doing so evaded the inevitable route into crisis and revolution envisaged by Kuhn. The next section shows how the attempted “monopolistic competition revolution” of the 1930s was not able to overthrow mainstream economics and thus represents a formidable exception to Kuhn’s theory.

Problems In Modern Microeconomics

Many economists believe that economics went wrong in the 1930s when the monopolistic competition revolution emerged. Surprisingly, shortly thereafter it died. The Keynesian and the mathematical Walrasian revolutions destroyed it.

The Monopolistic Competition “Revolution”

Marshallian economic theory assumed perfect competition as the ideal market structure. The use of the term was just as vague as the unshakable belief that competition would solve any problem that arose. Formalists began to scrutinise the laissez faire theory and frowned upon the ambiguous use of the term competition. Critics argued that it could not even be observed in the real economy, as market concentrations were high and/or rising in the U.S. at the beginning of the twentieth century. More intriguingly, the criticism was levelled that Marshallian analysis was incompatible with perfectly competitive equilibrium – monopolistic, not competitive market structures would prevail in equilibrium – if there are decreasing costs. The scientific focus was shifted towards the investigation of intermediate market structures between monopoly and competition. More work in this direction propelled “Jacob Viner’s integration of firms’ long-run and short-run cost curves, Joan Robinson’s theory of imperfect competition and Chamberlain’s theory of monopolistic competition”, (Landreth & Colander 1989). Viner solved the puzzle of reconciling theory and observation by splitting short and long run costs to establish increasing short-run-marginal-costs in the short run with fixed capital and diminishing marginal returns irrespective of the degree of the returns to scale. Robinson produced the nowadays so familiar equation of marginal revenues and marginal costs of imperfectly competitive firms. Chamberlain was the one who sought to initiate a revolution by going beyond normal science. In Landreth & Colander (1989) he is quoted, “monopolistic competition […] is a challenge to the traditional viewpoint of economics that competition and monopoly are alternatives and that individual prices are to be explained in terms of either the one or the other”⁴. He pointed to the error of the “old” duopoly models of neglecting the interdependence of the firms and combined monopoly and competition to formulate the model of monopolistic competition with interdependence.

The Revolution That Wasn’t

Chamberlain backed his idea with empirical observation that the concept of the competitive process bears in it the striving to obtain and maintain a monopoly. So, he induced that markets work according to monopolistic competition. The implication of this is that the perfectly competitive market should no longer be the ideal of welfare economics. Not only did he argue that perfect competition would not establish anyway, indeed, he also questioned the desirability of such markets - first and foremost with the fear of product overstandardisation under perfect competition. In sum, he demanded the substitution of the competitive ideal by an ideal including both competition and monopoly to a reciprocal degree of a kind still to be spelled out at that time. This common-sense approach was convincing in the late 1930s. And indeed the revolution found many advocates and gained momentum. Yet, by the 1950s, the attempt to revolutionise mainstream economics came to a halt. This was mainly because of the difficulty to formalise it (e.g. distinguish autarkic production cost from product differentiation costs, which would influence the demand) and draw conclusions from it. Interdependencies between firms, as present in the many oligopolistic markets in the U.S. of that time could not be modelled. It was thus hard to include it into general equilibrium analysis and still today remains somewhat distant to the competitive model.

The problem however remains that many markets today are to be positioned somewhere between competition and monopoly. By the 1980s, economist such as Stiglitz and Akerlof have explored the implications of monopolistic underpinnings for macro-models and found them to be inline with Keynesian conclusions. Advanced mathematical techniques suddenly rendered the monopolistic competition compatible with modern microeconomics. The renewed interest proved fruitful in anticompetitive behaviour analysis and welfare consequences of market power that would from then on include (the substantial) monopolisation costs as well. In Landreth & Colander (1989) yet another application of monopolistic competition in modern microeconomics is described. As it arguably draws upon ideas from institutionalism or political economy it provides nonetheless quite a comeback for Chamberlin’s theory, which he probably had not envisaged when writing it. They state that,

“(t)his theory [‘neoclassical political economy’^[5] ] assumes that people maximise not only within an assumed institutional structure but also to achieve an institutional structure most beneficial to them […]. This approach has led to the reintroduction of a type of monopolistic competition, since it accords with Chamberlin’s thesis that individual are continually trying to create monopolies for themselves.”

They seem to succeed in defending mainstream microeconomics against Chamberlain’s criticism that any competitive process inherently yields monopolies of some kind by stating that

“the emphasis is reversed: the new analysis yields not monopolistic competition but competitive monopolies, in which the desire to achieve monopoly is the central driving force held in check only by the attempts of others to get a part of that monopoly for themselves. Thus, the creation of monopoly provides competition for existing monopolies and that competition occurs only in the presence of monopoly.”⁶

At least to this extent has the monopolistic competition revolution been stifled. The mainstream economics paradigm it seems is here to stay.

Conclusion

From the observation of high market shares in reality, Chamberlain induced that markets function according to monopolistic competition. Consequently the ideal of perfect competition should be abandoned in welfare economics because it just will not occur. Chamberlin’s theory influenced the works of the scientific community at that time towards the analysis of intermediate market structures. Economists like Viner and Robinson flocked to these new kinds of studies. As laid out in section 2 they were willing to try out new ideas and follow new threads. Chamberlain though, was the one who sought to initiate a revolution by going beyond normal science. The underlying common sense appeal of his new paradigm was, however, also the reason for its demise, as it could not live up to the standards of formalisation and prediction. With the words of Kuhn, the new paradigm was not able to outperform the old one in terms of explanatory power. Due to this failure it is doomed to only attract insufficient number of adherents and remains unable to revolutionise. This is inline with Kuhn. So far, so good. When he claims however that a paradigm must leave room to incorporate new discoveries he should have admitted that it compromises the theory of scientific revolution. To explain, normal science seeks to suppress novelties. The following well-entrenched paradigm is almost impossible to overthrow. But, this is not only because it is made so rigid by normal science but much more because it has the assimilation capability i.e. to integrate theories or concepts of challenging enemy paradigms. What was heralded as the monopolistic competition revolution was turned down despite contradictive assumptions and predictions. But, in later years the concept of monopolistic competition was even integrated into mainstream economics and hence posed no threat to the dominant paradigm any longer. Scientific revolution may thus seem less frequently observable than anticipated or predicted by Kuhn.

Reference list

Chamberlin, E.H. (1950). The Theory of Monopolistic Competition, 6th ed., Cambridge, Harvard University Press.

Chalmers, A. F. (1999). What’s this thing called Science. 3rd ed., Queensland, University of Queensland Press.

Kuhn, T., (1962). The Structure of Scientific Revolutions, Chicago, University of Chicago Press.

Landreth, H. & Colander, D.C. (1989). History of Economic Theory. 2nd ed. Boston, Houghton Mifflin Company.

Pheby, J. (1988). Methodology and Economics - A critical introduction. London, MacMillan.

Robinson, J. (1933). The economics of imperfect competition. London, Macmillan.

Von Dietze, E. (2001). Paradigms explained: rethinking Thomas Kuhn’s philosophy of science. Westport, Praeger Publishers, Greenwood Publishing Company, Inc.

Internet resources

http://philosophy.wisc.edu/hausman/papers/enc-617.htm

http://www.startrek.com/library/borg/default.asp

[...]

¹ http://www.startrek.com/library/borg/default.asp : “In striving for their version of "perfection," the Borg assimilate civilizations whose technology they are interested in. When encountering a ship that catches their attention, the Borg usually will first sweep it with their sensors and then transport drones over to investigate the technology more closely. If they deem the vessel and its occupants worthy of assimilation, they will typically introduce themselves by saying, "We are the Borg. Existence as you know it is over. We will add your biological and technological distinctiveness to our own. Resistance is futile." They will then acquire the vessel by force and assimilate the occupants by first injecting them with nanoprobes, then implanting cybernetic technology in their bodies. The assimilated individual loses all sense of identity — his body and mind are turned entirely over to the Borg and their purposes.” (emphasis added). I was captured by this analogy when learning how the idea of ‘monopolistic competition’ was “digested” by the rival but dominant mainstream economics paradigm.

² “A general statement asserting the validity of the principle of induction is [here] inferred from a number of individual instances of its successful application. The argument is therefore itself an inductive one. Consequently, the attempt to justify induction by an appeal to experience involves assuming what one is tying to prove. It involves justifying induction by appealing to induction, and so is totally unsatisfactory” (Chalmers 1999: 51)

³ Kuhn compared paradigm change to political system change – much like the struggle between capitalism and communism, which also seemed to be stripped of any rational arguments.

⁴ E.H. Chamberlin; The Theory of Monopolistic Competition, 6th ed.; Cambridge; Harvard University Press, 1950), p. 204

⁵ The combined work of Jagdish Bhagwati and Mancur Olsen was named “neoclassical political economy”.

⁶ In Landreth & Colander (1989), p. 343.