Key insights and ideas for thirteen core topics in economics, organised by selecting the most relevant theoretical approaches per topic and contrasting them with each other.
This chapter provides a map through the complex jungle of economic theories. There are many different theoretical approaches, and each aspect of the economy has been analysed by a number of different ones. However, it is neither feasible nor productive for students to engage with every possible angle for every topic. Hence, the chapters on different topics, together with Building Block 8: Economic Theories, sets out an alternative approach: pragmatic pluralism. Rather than pursuing the extreme of either only focusing on one approach, or including every possible strand of thought for every topic, we propose a pragmatic middle ground: teaching a select number of approaches for each topic. In this way, it is possible to introduce students to the variety and diversity of economic thinking, whilst still having enough time and space to properly discuss each of the insights in detail with them.
Markets make up much of contemporary economies, organising more and more aspects of our lives. But how do markets function? Is competition between firms more like a gentle process of balancing, or a ruthless war of attrition? Do markets facilitate rational allocation, or are they more often defined by manipulation, norms, and power struggles? And how do markets relate to broader society?
Main opposing perspectives
■ Classical political economy: Competition as a ruthless process
■ Neoclassical economics: Competition as an optimal outcome
Main complementary perspective
□ Cultural approach: Markets are embedded in social structures
Additional perspectives and insights
+ Behavioural economics: People can be manipulated
+ Austrian school: Markets excel at spreading information
+ Field theory: Market stabilisation through social and formal rules
Main opposing perspectives: Classical political economy and neoclassical economics
There are two dominant perspectives on market competition. One view sees it as a harmonious outcome and the other sees it as a ruthless process. The static perspective (competition as an outcome) is mainly used by neoclassical and post-Keynesian economists, while the dynamic perspective (competition as a process) is mostly used by classical, Marxian, Austrian, evolutionary and complexity economists, as well as by business scholars. The neoclassical story starts from the Pareto-optimal perfect market, characterised by rationally self-interested behaviour of many buyers and sellers, complete secondary markets, perfect information and factor mobility, no market power, no transaction costs, and no externalities. If any firm is, however, able to acquire more profit than “normal”, then the neoclassical competition-as-end-state view assumes there is some imperfection in the market, otherwise economic “forces” would return the market to a competitive optimal equilibrium. Much of neoclassical economics is, therefore, devoted to solving these market failures, with dedicated fields such as industrial organization, environmental economics, game theory, information economics, organizational economics, and public economics. In the dynamic competition-as-war view, differing rates of profit are not understood as an imperfection, but as an inherent part of the rivalry and fighting between firms, which always creates winners and losers. Equilibrium and arbitrage in this dynamic approach are not realized at one point in time, but over time through periods of under- and overshooting.
Both approaches recognise how market competition can create economic prosperity, but do so in a different way. The static perspective emphasises allocative efficiency, which refers to the maximization of consumer utility. For this products have to be produced at the lowest costs possible and consumed by those who value them most. Neoclassical economists generally argue utility cannot be compared between individuals and therefore assume that the highest bidders are the one’s valuing the product most. The dynamic perspective, instead, emphasises dynamic efficiency, which refers to the reduction of production costs over time. The static perspective thus mainly focuses on consumer demand and elasticities, while the dynamic perspective draws more attention to innovation and the productive processes inside and between firms.
Within these two broad analytical strands, as well as within the various schools of thought, there are many specific theories about how prices, costs and profits are formed. It is beyond the scope of this chapter, and most courses, to review and summarize each of these (for this see, for example, Dobb, 1975, and chapter 8 in Shaikh, 2016), so we will limit ourselves to a key example for both strands. A recent reformulation of the dynamic approach to understanding markets is provided by Shaikh (2016). He builds a broad range of ideas and research from Smith, Ricardo and Marx to Kalecki, Harrod, and Andrews, among others, and in doing so develops a labour, or cost-of-production, theory of value. Interestingly, he also builds on the insight of Becker (1962) that the key empirical consumption patterns, such as downward sloping demand curves, Engel’s Law, and Keynesian type consumption functions, can be derived without assuming rational utility maximization and only requires two assumptions: that there is a budget constraint and a minimum level of consumption for necessary goods. Most microeconomics textbooks build on the neoclassical utility theory of value to explain prices, costs and profits (examples of microeconomics books). A key difference between the two approaches is whether prices are set so that marginal costs are equal to marginal revenue, profit is maximized and fluctuations in demand cause price fluctuations, as neoclassical economics assumes. Or whether competition forces firms to engage in price-cutting behavior, which is ultimately limited by production costs, as Shaikh argues.
Main complementary perspective: Cultural approach
While the above perspectives focus on the internal workings of markets, economic sociologists investigate how markets are embedded in society. Rather than existing in an a-social vacuum, markets are constructed and maintained by socially situated human beings. In this way, markets and the state are not understood as each other’s opposites or enemies, but as building on each other. Markets are social institutions that require government action to be created and expanded. Within economic sociology, social network analysts focus mainly on how social relationships influence market processes, while the cultural approach emphasises how economic practices are shaped by cultural norms and popular ideas.
A key insight of the cultural approach is that the boundaries and rules of markets are culturally determined. Cultural conceptions and moral values shape what we see as being appropriate to be bought and sold. A famous example of this is that life insurance only became culturally acceptable at the end of the 19th century after a prolonged marketing campaign by companies. Another important insight is that economics itself influences how we think markets should work. For example, auction theory is perhaps just as much about how auctions should work as how they do work. In the real world, auctions have become more like the neoclassical representations of them. This influence on the design of auctions comes either directly through the hiring of economists, or indirectly through the impact these ideas have on the thinking of non-economists. Economics as a discipline has therefore become crucial in various cognitive processes that in turn shape economic processes, creating difficult questions for the philosophy of science.
Additional perspectives and insights
Beyond these three main perspectives, various schools of thought both inside and outside of economics add to our understanding of markets by providing specific insights.
Behavioural economists, mainly inspired by psychology, focus on studying how people behave in experiments. Here they found that, in contrast to neoclassical theory, people have cognitive limitations and are therefore bounded rational. This implies that we often make decisions which do not optimise our own utility and that we are susceptible to outside influences on our decision-making, whether that is by firms through marketing or by governments through nudging. In this way, behavioural economics is often seen as a ‘positive’ theory of how consumer behavior deviates from the neoclassical “rational maximizing model [which] describes how consumers should choose”, which is taken as (normative) benchmark (Thaler, 1980, p. 39).
The Austrian school argues, on the other hand, that through the price mechanism, markets give us important information for economic coordination. Instead of seeing market decisions as easily misguided and manipulated, the Austrian view of markets is that they allow for collective wisdom. In fact, in this view the price mechanism is the only way in which so much local and subjective information can feasibly be collected and communicated.
Field theory’s approach to markets, sometimes referred to as markets-as-politics and closely related to the cultural approach, focuses on how markets are built and structured through social power struggles. Markets are understood as meso-level social fields, arenas in which the game of jockeying for position constantly plays out. When organising markets it is necessary to create a stable order in which competition does not take destructive forms. This stabilisation generally comes about through an interplay between entrepreneurs and the state, which not only provides a general social and legal order but also is an active participant and regulator.
Chapters & Papers:
- Economics After The Crisis by Irene van Staveren, from 2015, chapter 5. This well-written textbook which in one chapter sets out the neoclassical, post-Keynesian, social economic and institutional perspectives on markets.
- The Economy by The CORE Team, from 2017, chapters 8, 11 & 12. This successful textbook introduces students to the economics of market competition, rent-seeking, and market failures.
- Principles of Economics in Context by Jonathan Harris, Julie A. Nelson and Neva Goodwin, most recent edition from 2020, chapters 17 & 18. This useful textbook, which pays particular attention to social and environmental challenges, contains two chapters on markets with and without power.
- Capitalism: Competition, Conflict, Crises by Anwar Shaikh, from 2016, chapters 7, 8 & 9. This impressive and extensive book compares theories and empirics on many traditional economic topics including competition and prices.
- The Routledge Handbook of Heterodox Economics: Theorizing, Analyzing, and Transforming Capitalism by Tae-Hee Jo, Lynne Chester, and Carlo D’Ippoliti, from 2017, chapters 25 & 35. This broad and diverse book sets out a variety of theories on labour processes and full employment.
- Alternative Ideas from 10 (Almost) Forgotten Economists by Irene van Staveren, from 2021, chapter 9. This book emphasizes often ignored and neglected ideas and contains chapters on the ideas of Adam Smith on the abuse of markets.
- The Handbook of Economic Sociology by Neil J. Smelser and Richard Swedberg, from 2005, chapter 11. This extensive and yet accessible book for non-sociologists, provides an impressive and useful overview of the field of economic sociology, including a chapter on markets.
- The Microeconomics of Complex Economies: Evolutionary, Institutional, Neoclassical and Complexity Perspectives by Wolfram Elsner, Torsten Heinrich, and Henning Schwardt, from 2014, chapters 5-7. This innovative textbook makes readers familiar with new insights coming from frontier mainstream economic research, with three chapters devoted to the neoclassical theory of markets as well as critiques and how the real world deviates from it.
- Classical vs. Neoclassical Conceptions of Competition by Lefteris Tsoulfidis, from 2011. A useful article introducing students to the two main opposing perspectives on markets: the dynamic process view and static equilibrium view.
- Varieties of Field Theory by Daniel Kluttz and Neil Fligstein, from 2016. This chapter introduces students to field theory and its understanding of markets by providing an overview of its different strands.
- Markets as Politics: A Political-Cultural Approach to Market Institutions by Neil Fligstein, from 1996. This influential article sets out core ideas of the field theoretic approach to markets.
- Irrational behavior and economic theory by Gary Becker, from 1962. In this classic article, Becker, a key prominent of neoclassical economics, shows how many key empirical microeconomic patterns derived without assuming rational utility maximization.
- Toward a positive theory of consumer choice by Richard Thaler, from 1980. In this influential article, Thaler, a leading behavioural economist, argues we should understand neoclassical theory as being normative, describing how people should behave, and behavioural economics as providing a descriptive theory of how people actually do behave.
- The architecture of markets: An economic sociology of twenty-first-century capitalist societies by Neil Fligstein, from 2001. This book introduces students to the field theoretic approach to markets, paying particular attention to institutions, employment systems, corporate governance and globalization.
- The Social Structures of the Economy by Pierre Bourdieu, from 2000. This book presents an extensive and detailed analysis of the French housing market followed by a short introduction into the field theoretic approach to studying markets.
- The Great Transformation by Karl Polanyi, from 1944. This classic describes the history of markets and its social embeddedness.
- Do Economists Make Markets? On the Performativity of Economics by Donald MacKenzie, Fabian Muniesa and Lucia Siu, from 2008. This influential collection of essays gives an introduction and overview of the literature on performativity and analyzing markets through a cultural lens.
- Economic Lives: How Culture Shapes the Economy by Viviana Zelizar, from 2010. This book brings together the literature using a cultural approach to understand the economy and markets, discussing issues related to pricing, money, intimacy, care and commerce.