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Imperfect Competition and the Critique of the Representative Firm

Sraffa’s 1925 Italian paper was followed by a much shorter article in the Economic Journal (Sraffa 1926), the first half of it consisting of a summary of the Italian article, while the second half elaborates an original line of research: a theory of imperfect competition, which has the advantage of being compatible with the cases of increasing and constant returns as well while embodying realistic features suggested in Marshall’s writings. The idea is that, as a consequence of market imperfections, within every industry each firm is confronted with a specific, negatively sloped demand curve, even when many firms are simultaneously present in the industry, while according to the traditional theory of competition in this case each firm should be faced with a horizontal demand curve. However, Sraffa stressed the limits of this approach, since it ignores the possibility of new firms entering the industry, thus neglecting competition in the classical sense of the term, consisting of the shifting of capital from one sector to another in pursuit of the maximum returns. Thus Sraffa did not share in the enthusiasm for imperfect competition raging in the 1930s, turning, rather, to the classical notion of competition, which constituted the basis for the line of research that led to his 1960 book on Production of Commodities by Means of Commodities.

Sraffa’s radical departure from the traditional framework of the theory of the firm and the industry was evident in his contributions to the symposium on ‘Increasing Returns and the Representative Firm’ published in the Economic Journal in March 1930. The conclusion of these brief contributions was a clear-cut break with the then mainstream views: ‘Marshall’s theory ... cannot be interpreted in a way which makes it logically self-consistent and, at the same time, reconciles it with the facts it sets out to explain’; thus, ‘I think ... that [it] should be discarded’ (Sraffa 1930, p. 93).

Here Sraffa’s criticism was levelled against Robertson’s (1930) evolutionary version of the Marshallian theory, based on the concept of the firm’s life cycle, which Marshall had employed in an attempt to make increasing returns compatible with the firm’s competitive equilibrium. Like a biological organism, the firm goes through successive stages of development, maturity and decline; the representative firm is half-way through the process of development and thus at a stage of increasing returns to scale. As Marshall himself pointed out, a concept of this type, that sees the expansion of firms depending on the life cycle of entrepreneurial capacities, may be plausible in the case of directly family-run concerns but cannot apply to modern joint stock companies.

Thus biological analogies prove a false exit to the blind alley Marshallian analysis had got into, hemmed in by the contradiction between increasing returns and competitive equilibrium. Sraffa had an easy task in pointing out the deus ex machina nature of the biological metaphors, which cannot fill in the gaps in logical consistency intrinsic to these analytic structures: ‘At the critical points of his argument the firms and the industry drop out of the scene, and their place is taken by the trees and the forest, the bones and the skeleton, the water-drops and the wave - indeed all the kingdoms of nature are drawn upon to contribute to the wealth ofhis metaphors’ (Sraffa 1930, p. 91).

 
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