RIFT VALLEY UNIVERSITY

SIDIST KILLO CAMPUS

Department: Master of Business Administration (MBA)
Group Assignment of Managerial Economics
Title: Article Review (The impossibility of a perfectly competitive labour
market)
Section: B
Group Name: ID No:
1. Solomon Tesfaye MBA/0085/22
2. Abdisa Hailu MBA/1002/22
3. Ephrem Alemayehu MBA/1008/22
4. Dereje Getachew MBA/1063/22
5. Eyob Hussen MBA/0099/22
6. Rahel Zerihun MBA/0182/22
7. Woynshet Fekadu MBA/0174/22
8. Zeritu Teferi MBA/0175/22
Submitted to: Dr. Tesfaye H.
Submission Date:- Jan, 2023 G.C
Addis Ababa, Ethiopia

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Bruce E. Kaufman Studies “The impossibility of a perfectly competitive labour market”

A. Description of the Study

“The impossibility of a perfectly competitive labour market” by Bruce E. Kaufman. It was
published in the Cambridge Journal of Economics in 2007. The paper argues that the model of a
perfectly competitive labour market is a logical impossibility because it presumes zero transaction
costs, but the very condition of zero transaction costs causes the labour market, employment
relationship and labour demand curve to disappear. The paper also discusses the implications of
positive transaction costs for labour market outcomes and wage determination. The paper uses the
insights of institutional economics, both of the original and new variety, to critique the neoclassical
paradigm and offer alternative perspectives on labour economics
- What was the purpose of the research?
The main purpose of the study is to show that the model of a perfectly competitive labour market
is a logical impossibility, based on the institutional theory of transaction costs.

- Why is the research being conducted & why is it considered significant?

This article is about the theoretical impossibility of a perfectly competitive labour market, based
on the concept of transaction costs. The main points:

 A perfectly competitive labour market requires zero transaction costs, but this condition
implies that all labour is hired as independent contractors through the product market, and thus
the labour market and the employment relationship disappear
 With positive transaction costs, labour markets exist but employment contracts are incomplete
and the labour supply curve to firms is upward sloping, making the labour demand curve ill-
defined and the wage rate indeterminate.

B. Literature Evaluation
- Does the literature review seem thorough & recent (within the last 5 years)?
The literature review of this article seems to be thorough and recent. Here are some reasons: The
article cites over 100 references, most of which are from reputable journals and books in the
fields of economics, sociology, and law. The article covers a wide range of topics related to the
theory and practice of labour markets, such as perfect competition, transaction costs, institutional
economics, employment contracts, wage determination, efficiency wages, monopsony, and
industrial relations. acknowledges the contributions of heterodox traditions such as post-
Keynesian and radical economics.

- Does the content of the literature review relate directly to the research problem?
The content of the literature review directly relates to the research problem. The author uses the
institutional theory of transaction costs to show that with zero transaction costs, labour is hired as

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independent contractors through the product market, and with positive transaction costs, labour
contracts are incomplete and the labour supply curve to the firm is upward sloping, making the
labourdemand curve ill-defined. The author suggests that wage rates are not determined by the
intersection of labour demand and supply curves, but are a form of administered or bargained price
that depends on various industrial relations factors. The author also challenges the efficiency and
self-equilibrating properties of the competitive model. Therefore, the literature review is directly
related to the research problem of demonstrating the logical impossibility of the perfectly
competitive labour market model and its implications for wage determination and the core
paradigm of neoclassical labour economics.

C. Method and Design

- Describe the study design – is it appropriate?
The study design of the article you have opened is not explicitly mentioned. However, the article
seems to be a theoretical and empirical review of the literature on labour markets, rather than an
original research study.
The study design of this article is not applicable in the traditional sense of research methodology,
but rather a review of existing literature. Nonetheless, the authors have employed a rigorous and
systematic approach to their analysis, and have provided valuable insights into the limitations and
possibilities of labour market theory and practice.

- How was the research conducted? (The study procedure itself) & data collected
This article was conducted by using a theoretical line of reasoning based on the institutional theory
of transaction costs. The author did not collect any empirical data, but instead relied on the ideas
and arguments of previous economists, such as Commons, Coase, Williamson, and Robinson, to
demonstrate the logical impossibility of a perfectly competitive labour market..

D. Analysis
- How were the data analyzed?
The data of this article were analyzed using the institutional theory of transaction costs. This theory
compares the costs and benefits of different modes of economic organization, such as markets and
firms. The author usdoes this theory to show that the assumptions of the competitive labour market
model are inconsistent and lead to the conclusion that a perfectly competitive labour market is a
logical impossibility. The author also discusses the implications of positive transaction costs for
the existence and nature of labour markets, employment relationships, and wage determination.

- Do the selected statistical tests appear appropriate?

The selected statistical tests do not appear appropriate for this study, as this study does not
contain any empirical data or quantitative analysis.

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- Were the results significant?
This article “The Impossibility of a Perfectly Competitive Labour Market” argues that the model
of a perfectly competitive labour market is a logical impossibility, based on the concept of
transaction costs and the institutional nature of labour contracts.
The article suggests that the theoretical problems of the perfectly competitive model have
significant implications for labour economics, such as the role of institutions, wage rigidity, and
policy interventions.

E. Results
- What were the findings of the study?
The findings of this article are:
The impossibility of a perfectly competitive labour market: The article argues that the
assumptions of the neoclassical model of a perfectly competitive labour market are internally
contradictory and lead to the conclusion that such a market is a logical impossibility.
The implications of positive transaction costs: The article also shows that positive transaction
costs, which are necessary for the existence of labour markets and employment relationships,
invalidate the predictions of the neoclassical model.
The need for institutional analysis: The article suggests that the theoretical flaws of the
neoclassical model call for more attention to models of imperfect competition and the role of
institutions in wage and employment determination, as advocated by institutional, post-Keynesian,
and other heterodox economists. The article also indicates that institutional economics can offer
not only a critique of orthodoxy but also insightful theory of its own.

- Are the results presented in a clear and understandable way?

The results presented in this article are not very clear and understandable, as the author does not
provide any empirical evidence or data to support his theoretical argument. The article is mostly
based on logical deductions from the assumptions of the neoclassical and institutional models of
labour markets, without testing or verifying them with real-world observations.

- How did the authors interpret the results?

Interpreted the results as follows:
Theoretical contradiction: They argued that the assumptions of the perfectly competitive labour
market model are internally contradictory and lead to the conclusion that such a market is a logical
impossibility. This is because zero transaction costs, which are necessary for perfect competition,
would eliminate the need for multi-person firms, employment contracts and labour markets.

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Empirical implications: They suggested that the theoretical flaws of the competitive model
compromise its empirical predictions and relevance, and that alternative models of imperfect
competition and institutional factors are needed to better explain wage and employment outcomes
in real labour markets.
Integration of institutional economics: They demonstrated that the institutional theory of
transaction costs, which originated from the work of John R. Commons and was developed by
Ronald Coase, Oliver Williamson and others, can offer a fruitful critique and extension of
neoclassical economics, and that the original and new versions of institutional economics can be
integrated.

- Were there any study limitations discussed?

 Theoretical critique: The article challenges the core assumptions and predictions of the
neoclassical perfectly competitive labour market model, but does not provide a positive
alternative theory or empirical evidence to support its claims.
 Scope of analysis: The article focuses on the logical impossibility of a perfectly
competitive labour market, but does not address the implications of imperfect competition
or other forms of market failure for labour market outcomes and policies.
 Relevance of the argument: The article acknowledges that modern labour economics has
moved beyond the simple competitive model, and that positive transaction costs are
inevitable in reality. Therefore, the argument may be seen as a curiosum that does not affect
the main corpus of neoclassical economics or its applications.
 References: The article relies heavily on older and heterodox sources, such as Commons,
Coase, Simon, and Robinson, and does not engage with more recent and mainstream
developments in labour economics, such as search and matching models, contract theory,
and behavioural economics.

F. Subject matter significance

- What were the implications of this study to practitioners?
The implications of this study to practitioners are:
The limitations of the neoclassical model: Practitioners who rely on the neoclassical model of
labour markets to guide their decisions and policies may be misled by its unrealistic and
contradictory assumptions. The model fails to account for the institutional and organisational
factors that affect wage and employment outcomes, such as transaction costs, contract
incompleteness, bargaining power, and efficiency wages.
The importance of institutional analysis: Practitioners who adopt an institutional perspective on
labour markets can gain a deeper and more realistic understanding of the economic behaviour and
outcomes of firms and workers. Institutional analysis can help explain the existence and evolution
of labour markets, employment relationships, and wage determination mechanisms, as well as the
sources and consequences of market imperfections and inefficiencies.
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The need for alternative models and empirical methods: Practitioners who seek to improve the
performance and welfare of labour markets may benefit from exploring alternative models and
empirical methods that incorporate institutional factors and recognise the diversity and complexity
of labour market phenomena. Such models and methods may offer more accurate predictions, more
relevant explanations, and more effective interventions than the neoclassical model.

- How does the study contribute to the body of knowledge?

The study contributes to the body of knowledge by challenging the neoclassical model of labour
markets and offering an alternative perspective based on the institutional theory of transaction
costs. The study shows that the assumptions and predictions of the neoclassical model are logically
contradictory and empirically invalid, and that the institutional model provides a more realistic
and insightful explanation of the existence and functioning of labour markets and employment
relationships. The study also suggests some implications and directions for future research in
labour economics.

- Could the study be replicated?

The study could be replicated if the following conditions are met:

 The replicator has access to the same sources of literature that the author used, or can find
equivalent ones.
 The replicator has sufficient knowledge of the theoretical concepts and models that the author
employed, such as transaction costs, incomplete contracts, monopsony, and efficiency wages.
 The replicator can follow the logical reasoning and arguments that the author presented, and
can critically evaluate their validity and relevance.
 The replicator can acknowledge the limitations and assumptions of the neoclassical and
institutional perspectives, and can compare and contrast their predictions and implications.

- What additional questions does the study raise?

Some additional questions that the study raises are:

 How do transaction costs vary across different types of labour markets and employment
contracts?
 How do other factors, such as preferences, norms, and regulations, affect the choice between
employment and sales contracts? The study focuses on the role of transaction costs in
explaining the existence of the employment relationship and the labour market, but does not
consider other possible factors that may influence the decision of workers and firms to enter
into an employment or a sales contract.
 How do changes in technology and the nature of work affect the transaction costs and the
optimal mode of governance for labour? The study is based on a static analysis of the trade-off
between transaction costs and production costs in determining the optimal mode of governance
for labour.