In respect to quantity produced, the firm’s demand is constant in perfect competition and declining in imperfect competition, while unit cost is rising. So, an increase of production leads to the fall of the excess of marginal revenue over marginal cost. And profit will be at maximum when production is so adjusted to equalize them. This is the well-known rule stated by mainstream economists. But let us not forget that it is only short term equilibrium. New firms are attracted by this profit. Supply increases and market price falls till when there is no profit any more. That is long term equilibrium. Average cost equals average revenue (price), marginal cost equals marginal revenue and the four variables are equal when perfect competition prevails.
Is there not something inconsequent in this scenario? If firms in short term equilibrium had lowered their price, they could have sold a larger product at the same price as the one prevailing in full equilibrium. To be sure, net profit would not have been higher, but the remuneration of capital (considered as a cost, but which is an income) would. So this alternative behaviour can be considered as more advantageous. And agents are said to be rational, so they would choose it. The conclusion is that mainstream economics is not as thorough as it seems, regarding to its reputation.
A debate happened between marginalist and anti-marginalist economists about this question from 1939 to +/- 1960. The official story is that marginalists won the debate. Some anti-marginalists had the bad idea to deny that firms try to maximise profit. The actual fact is that firms try to maximise long-term profit; and maximising short-term profit, because of the appeal of new competitors, could harm long-term profit.
The “Marginalist Controversy”, as well as my own (heterodox) view on the subject, is explained in my article ”Price, Target Rate of Profit and Entry Preventing”, present on the MPRA site at the address:
[size=Trebuchet MS]Since the marginalist controversy held from 1939 to the mid-fifties, the full cost principle presents itself as an alternative to the marginalist theory of the producer’s equilibrium, without being able to shake its dominance. Yet, through decades, empirical investigations are rather favourable to it. Its rationality has not been sufficiently emphasized; so, orthodoxy was able to belittle it as an empirical practice compatible with its own precepts.
The present article shows that three principles stated by the full-costers and their successors would allow to build a sound theory of full cost pricing. These are: - preventing entry of new competitors; - target rate of profit; - competitive price leadership
The article proves that full cost pricing is more conducive to profit maximization than marginalist rule, especially in the case of a competitive market with few suppliers, a market structure usually neglected by microeconomics. Opponents to full cost pricing often consider changes in demand as its Achilles heel. The present article analyses this problem in depth.[/size]
Paolo Sylos-Labini, an economist who deserves to be better known