This book represents the culminating point that was started in the research of Ludwig von Mises during the 1920's in his socialist calculation argument and Hayek's business cycle theory during the 1930's. During their research, Hayek and Mises discovered that many points of economic theory previously believed to be well developed in reality were lacking basic theoretical foundations, this is especially true in modern microeconomic theory.
These problems were only unsatisfactorily addressed by Hayek in his economics and knowledge papers and even less satisfactorily addressed by Mises in his Human Action. Hence many problems remained: What's the implications of the knowledge problem to the basis of economics? How the market systems utilizes dispersed knowledge? What's the real nature of competition for economic science? Hayek and Mises provided some answers, but they were still laking a well developed theoretical framework.
In this ground breaking book, Kirzner provides the greatest advance in economic theory of the second half of the 20th century. He does that by explaining how the market manages to solve the knowledge problem, with is the problem of integrating dispersed bits of individual knowledge and hence, he explains how the market generates equilibrating tendencies. This theory finally explains how supply and demand tends to be equated, how prices tend to correspond to marginal cost and how the pattern of resource availability tends to be allocated to satisfy consumer's preferences. The answer is that competition for profit opportunities is the process by with gaps of the knowledge currently utilized by the economic system are filled by entrepreneurial discovery. Entrepreneurs compete because there is undiscovered knowledge awaiting to be discovered, and the ones with discover and exploit the opportunity first are the ones with will reap the surplus of mutually beneficial exchanges.
The model of "perfect competition" in reality represents the state were competition has ceased, the state were knowledge has been discovered and fully transmitted. Hence, this model fails to explains the emergence of market efficiency, but assumes it implicitly. However, the model of perfect competition explains clearly how a society in general equilibrium would look like. While the numerous models of imperfect competition in reality are useless to explain any economic phenomena, since they were developed because of a misunderstanding of the role to be performed by the perfect competition model.
The authors of the models of imperfect competition thought that the concept of perfect competition was developed to directly describe economic reality, and since it is an equilibrium model, it clearly didn't. However, the problem was in the equilibrium nature of the model, not in the characteristics of demand curves, as these authors thought. If we assume that everybody has perfect knowledge (with is the defining characteristic of equilibrium) prices will equal marginal costs, since if prices were higher than marginal costs, that would mean that the cost of producing one unit of a good would be smaller than the price of selling this good in the market. Hence the current level of production would be inconsistent with perfect knowledge, hence, not equilibrium.
The reality is that monopoly, defined as a barrier to entry, is inefficient because the knowledge of the opportunity to make mutually beneficial transactions is not fully utilized if any individual that is not the monopolist discovers such knowledge. That's because this possibility of pareto improving transaction will go unexploited from lack of utilization of existing knowledge. Hence, monopoly defined as a single seller is not always inefficient if the single seller emerges because he makes better offers than any other potential seller. In that case there are no other sellers because either all opportunities of mutual beneficial transactions are already exploited or those opportunities haven't been discovered by anybody yet.
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RENATO BARBOSA DA SILVA RAMOS
ISRAEL M. KIRZNER
Reviewed in Brazil on December 13, 2022
